CSW


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                       Central and South West Corporation

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                              1997 FINANCIAL REPORT











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TABLE OF CONTENTS


  Management's Discussion and Analysis of Financial Condition and Results
   of Operations                                                              1

  Consolidated Statements of Income                                          30

  Consolidated Statements of Stockholders' Equity                            31

  Consolidated Balance Sheets                                                32

  Consolidated Statements of Cash Flows                                      34

  Notes to Consolidated Financial Statements                                 35

  Report of Independent Public Accountants                                   66

  Report of Management                                                       69
 
  Glossary of Terms                                                          70








FORWARD LOOKING INFORMATION

This report made by CSW and its subsidiaries contains forward looking statements
within the meaning of Section 21E of the Exchange Act.  Although CSW and each of
its subsidiaries believe that, in making any such statements, their expectations
are based on reasonable  assumptions,  any such  statements may be influenced by
factors that could cause actual outcomes and results to be materially  different
from those  projected.  Important  factors  that could cause  actual  results to
differ materially from those in the forward looking statements include,  but are
not  limited  to:  the  impact of general  economic  changes in the U.S.  and in
countries  in which CSW  either  currently  has made or in the  future  may make
investments;  the impact of deregulation on the U.S.  electric utility business;
increased  competition and electric utility industry  restructuring in the U.S.;
the impact of the AEP Merger or other merger and acquisition  activity;  federal
and  state  regulatory  developments  and  changes  in  law  which  may  have  a
substantial  adverse  impact  on the  value of CSW  System  assets;  timing  and
adequacy of rate relief;  adverse changes in electric load and customer  growth;
climatic  changes  or  unexpected  changes in weather  patterns;  changing  fuel
prices, generating plant and distribution facility performance;  decommissioning
costs associated with nuclear  generating  facilities;  uncertainties in foreign
operations and foreign laws affecting CSW's investments in those countries;  the
effects of retail  competition in the natural gas and  electricity  distribution
and supply  businesses  in the  United  Kingdom;  and the timing and  success of
efforts to develop domestic and international power projects. In the non-utility
area,  the  aforementioned  factors  would also apply,  and, in addition,  would
include,  but are not  limited  to: the  ability to compete  effectively  in new
areas, including  telecommunications,  power marketing and brokering,  and other
energy  related  services,  as well as  evolving  federal  and state  regulatory
legislation and policies that may adversely affect those industries generally or
the CSW System's business in areas in which it operates.


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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

      Reference is made to CSW's Consolidated  Financial  Statements and related
Notes to  Consolidated  Financial  Statements and Selected  Financial  Data. The
information  contained  therein  should  be read  in  conjunction  with,  and is
essential in understanding, the following discussion and analysis.


OVERVIEW

      The electric  utility  industry is changing rapidly as it is becoming more
competitive.  In anticipation of increasing  competition and fundamental changes
in the industry,  CSW's  management is implementing a strategic plan designed to
help position CSW to be competitive in this rapidly changing  environment and is
developing an emerging global energy business.

      CSW has undertaken key initiatives in the  implementation  of this overall
strategy and is determining new directions for the corporation's  future. One of
these  new  directions  is the  proposed  merger  between  AEP and CSW  that was
announced in December 1997. CSW would become a subsidiary of AEP in the proposed
merger.  The  proposed  merger  would  join  two  companies  which  are low cost
providers  of  electricity  and would  achieve  greater  economies of scale than
either company could achieve on its own. In 1997, CSW International  doubled its
investment  in  a  Brazilian  electric   distribution  utility  and  made  other
investments  in Latin  America.  CSW continues to pursue the  acquisition of the
non-nuclear generating assets of Cajun, a Louisiana member electric cooperative.
C3 Communications' joint venture limited partnership, ChoiceCom, has entered the
local  telephone  markets in the Texas cities of Austin,  Corpus Christi and San
Antonio and plans to enter the markets of Dallas and Houston  offering a variety
of telecommunications  services.  These events are discussed below and elsewhere
in this report.

      CSW believes that, compared to other electric utilities, the CSW System is
well  positioned  to  capitalize  on  the  opportunities  and  challenges  of an
increasingly deregulated and competitive market for the generation, transmission
and distribution of electricity (The foregoing  statement  constitutes a forward
looking  statement within the meaning of Section 21E of the Exchange Act. Actual
results may differ materially from such projected  information due to changes in
the underlying  assumptions.  See FORWARD LOOKING  INFORMATION).  The CSW System
benefits  from  economies  of scale by virtue of its size and is a reliable  and
relatively  low-cost  provider  of  electric  power.  Specifically,   CSW  seeks
competitive advantages through its diverse and stable customer base, competitive
prices  for   electricity,   diversified   fuel  mix,   extensive   transmission
interconnections,  diversity of regulation and financial flexibility. See RECENT
DEVELOPMENTS AND TRENDS for additional information.


LIQUIDITY AND CAPITAL RESOURCES

      Overview of Operating, Investing and Financing Activities
      Net cash  provided by  operating activities decreased $149  million during
1997 compared to 1996. The decrease was primarily  attributable  to the December
1997 payment of $88 million on the first installment of the windfall profits tax
imposed on SEEBOARD  in the United  Kingdom.  In  addition,  increased  factored
accounts  receivable  purchases  at CSW  Credit,  federal  and state  income tax
payments for the gain on CSW's 1996 sale of Transok which totaled  approximately
$122  million  (after  being offset in part by the  utilization  of  Alternative
Minimum  Tax  credits  that CSW had  previously  generated),  and a $35  million
payment  related to the  settlement  of  litigation  between CSW and El Paso all
contributed to the decrease.  Offsetting part of the decrease, the U.S. Electric
Operating Companies realized greater fuel recovery during 1997 compared to 1996.

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      Net cash used in investing activities was $904 million in 1997 compared to
$1.3 billion in 1996. There were no acquisition  expenditures  during 1997 while
$1.4  billion  in  SEEBOARD  acquisition  expenditures  were made  during  1996.
However,  during 1996,  CSW received $690 million in cash on the sale of Transok
and $99 million on the sale of the  National  Grid shares.  During  1997,  while
CSW's total construction  expenditures decreased $14 million compared to 1996, a
combined total of approximately  $294 million was invested by CSW Energy and CSW
International in 1997 on several  projects  compared to $124 million in 1996. In
addition,  during  1997,  CSW Energy  made its final  payment on the Ft.  Lupton
cogeneration project which was more than offset by the reduction of CSW Energy's
equity  investment in the Orange  cogeneration  project when permanent  external
financing was obtained on the project.

      Net cash flows from financing  activities  decreased  substantially during
1997 compared to 1996. During 1996, CSW incurred substantial debt to finance the
acquisition of SEEBOARD. In addition, CSW sold approximately 15.5 million shares
of common stock and received  net  proceeds of  approximately  $398 million in a
primary public offering in 1996, the proceeds of which were subsequently used to
repay  a  portion  of  the  debt  incurred  in  connection   with  the  SEEBOARD
acquisition.  CSW Energy also issued $200  million in Senior  Notes during 1996.
During  1997,  CSW made  changes in its common  stock plans and stopped  issuing
original  shares  through these plans.  Consequently,  $20 million in new common
stock was issued  pursuant  to these  plans in 1997  compared  to $79 million in
1996.  CPL's  $200  million  Series BB, 6% FMBs also  matured in 1997.  However,
offsetting a portion of the decrease, the business trusts of CPL, PSO and SWEPCO
received cash proceeds of approximately  $323 million from the issuance of Trust
Preferred  Securities  during 1997. These proceeds were used primarily to redeem
preferred stock and repay short-term debt of the companies.

      The non-cash  impacts of exchange rate  differences on the  translation of
foreign currency  denominated assets and liabilities were recorded on a separate
line on the cash flow statement in accordance with accounting guidelines.

      Internally Generated Funds
      Internally  generated  funds,  which consist of cash flows from  operating
activities  less common and preferred stock  dividends,  should meet most of the
capital requirements of the CSW System.  However,  CSW's strategic  initiatives,
including  expanding  CSW's core  electric  utility and  non-utility  businesses
through acquisitions or otherwise,  may require additional capital from external
sources.  For a description  of certain  restrictions  on CSW's ability to raise
capital from external sources, see PROPOSED AEP MERGER. Productive investment of
net funds  from  operations  in  excess of  capital  expenditures  and  dividend
payments is necessary to enhance the long-term  value of CSW for its  investors.
CSW is  continually  evaluating  the best use of these funds.  CSW's  internally
generated  funds totaled $343  million,  $499 million and $451 million for 1997,
1996 and 1995, respectively.

      Capital Expenditures
      The CSW System's need for capital results  primarily from its construction
of facilities to provide  reliable  electric  service to its customers,  and the
historical  capital  requirements  of the CSW System have been primarily for the
construction  of electric  utility plant.  However,  current  projected  capital
expenditures are expected to be primarily for existing  distribution systems and
for various  non-utility  investments.  The U.S.  Electric  Operating  Companies
maintain a continuing  construction  program,  the nature and extent of which is
based upon  current  and  estimated  future  demands  upon the  system.  Planned
construction expenditures for the U.S. Electric Operating Companies for the next
three years are primarily to improve and expand distribution facilities and will
be funded primarily through internally  generated funds. These improvements will
be required to meet the anticipated needs of new customers and the growth in the
requirements of existing customers.

      CSW regularly  evaluates its capital spending policies and generally seeks
to fund only those projects and investments that management  believes will offer
satisfactory returns in the current environment.  Consistent with this strategy,

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the CSW  System  is  likely  to  continue  to  make  additional  investments  in
energy-related  and  non-utility  businesses  and will  continue  to search  for
electric  utility  companies or other  electric  utility  properties to acquire.
Primary  sources of capital for these  expenditures  are long-term  debt,  trust
preferred  securities and preferred stock issued by the U.S. Electric  Operating
Companies,  long-term and  short-term  debt issued by CSW, as well as internally
generated funds. Historically, the issuance of common stock by CSW has also been
a source of  capital.  CSW Energy and CSW  International  typically  use various
forms of  non-recourse  project  financing  to provide a portion of the  capital
required for their respective  projects as well as utilizing  long-term debt for
other  investments.  Although  CSW  and  each  of the  U.S.  Electric  Operating
Companies expect to fund the majority of their respective  capital  expenditures
for their existing utility systems through  internally  generated funds, for any
significant investment or acquisition, additional funds from the capital markets
may be required.  For a description of certain  restrictions on CSW's ability to
raise capital from external  sources,  including  through the issuance of common
stock, see PROPOSED AEP MERGER.

      The historical and estimated  capital  expenditures for the CSW System are
shown in the table below. The amounts include construction  expenditures for the
U.S. Electric Operating  Companies and, for SEEBOARD and CSW's other diversified
operations,  construction  expenditures and net equity investments.  It does not
include the $2.1  billion  used to acquire  SEEBOARD  during 1995 and 1996.  The
majority of the capital  expenditures for the U.S. Electric Operating  Companies
for 1995 through 1997 were spent on distribution  facilities.  It is anticipated
that the majority of the estimated  capital  expenditures  for 1998 through 2000
will be for  distribution  facilities  as well.  For a  description  of  certain
restrictions on CSW's ability to make capital  expenditures,  including  through
the issuance of common stock,  see PROPOSED AEP MERGER (The table and statements
below contain forward looking  information  within the meaning of Section 21E of
the Exchange  Act.  Actual  results may differ  materially  from such  projected
information  due to changes in the underlying  assumptions.  See FORWARD LOOKING
INFORMATION).


                                                             Estimated
                            1995    1996     1997      1998     1999    2000
                         --------------------------  -------------------------
                                       (millions including AFUDC)

Capital Expenditures       $495     $644    $760       $569    $586     $595

Estimated Capital Expenditures for 1998-2000 do not include expenditures for 
acquisition-type investments.


      Although CSW does not believe that the U.S. Electric  Operating  Companies
will require substantial  additions of generating capacity over the next several
years, the U.S. Electric  system's internal resource plan presently  anticipates
that any additional capacity needs will come from a variety of sources including
power purchases.  Refer to Integrated  Resource Plan for additional  information
regarding the U.S. Electric System's capacity needs.

      Inflation
      Annual inflation rates, as measured by the U.S. Consumer Price Index, have
averaged  approximately 2.4% during the three years ended December 31, 1997. CSW
believes that inflation, at this level, does not materially affect CSW's results
of  operations  or  financial  position.   However,  under  existing  regulatory
practice,  only the historical cost of plant is recoverable from customers. As a
result,  cash flows designed to provide  recovery of historical  plant costs may
not be adequate to replace plant in future years.

      Financial Structure, Shelf Registrations and Credit Ratings As of December
      31, 1997, the capitalization ratios of CSW were 45% common
stock  equity,  2%  preferred  stock,  4%  Trust  Preferred  Securities  and 49%
long-term debt. CSW is committed to maintaining  financial flexibility through a
strong  capital  structure and favorable  securities  ratings in order to access
capital markets opportunistically or when required. CSW continually monitors the
capital  markets  for  opportunities  to  lower  its  cost  of  capital  through
refinancing activities. CSW's estimated embedded cost of long-term debt for 1997
was 7.2%.

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      CSW can issue common stock,  either through the purchase and reissuance of
shares from the open market or original  issue shares,  to fund its LTIP,  stock
option plan,  PowerShare plan and ThriftPlus plan. Following the issuance of the
CPL 1997  Original Rate Order and the decline in the market price of CSW Common,
which CSW believes was attributable in part to the CPL 1997 Original Rate Order,
the  determination  was made that it was  appropriate  for CSW to begin  funding
these plans through open market  purchases,  effective  April 1, 1997.  Prior to
that time, CSW had issued $20 million in new common stock in 1997. CPL has shelf
registration  statements  on file for the  issuance of up to $60 million of FMBs
and up to $75  million  of  preferred  stock,  and PSO has a shelf  registration
statement on file for the issuance of up to $35 million of Senior  Notes.  For a
description  of certain  restrictions  on CSW's  ability to raise  capital  from
external sources, see PROPOSED AEP MERGER.

      The  current  securities  ratings  for CSW and each of the U. S.  Electric
Operating  Companies  is  presented  in  the  following  table,   including  the
securities rating on the Trust Preferred Securities issued by CPL Capital I, PSO
Capital I and SWEPCO Capital I.
                                     Moody's   Duff & Phelps  Standard & Poor's
                                     ------------------------------------------
CPL
First mortgage bonds                   A3             A               A
Senior unsecured                      Baa1            A-              A-
Preferred stock                       baa1           BBB+             A-
Trust preferred (CPL Capital I)       baa1           BBB+             A-
Junior subordinated deferrable        
   interest debentures                Baa2            --              --

PSO
First mortgage bonds                   A1             AA-            AA-
Senior unsecured                       A2             A+              A
Preferred stock                        a3             A+              A
Trust preferred (PSO Capital I)        a2             A+              A
Junior subordinated deferrable 
   interest debentures                 A3             --              --
   
SWEPCO
First mortgage bonds                  Aa3             AA             AA-
Senior unsecured                       A1             AA-             A
Preferred stock                        a1             AA-             A
Trust preferred (SWEPCO Capital I)    aa3             AA-             A
Junior subordinated deferrable
   interest debentures                 A2              --             --
  
WTU
First mortgage bonds                   A2              A+             A
Senior unsecured                       A3              --             A-
Preferred stock                        a3              A              A-

CSW
Commercial paper                      P-2             D-2            A-2

These  securities  ratings  may be revised or  withdrawn  at any time,  and each
rating should be evaluated independently of any other rating.

      Long-Term Financing
      On  April  24,  1997,  PSO's  business  trust,  PSO  Capital  I,  sold  to
underwriters  in a  negotiated  offering  $75  million,  8.00%  Series A,  Trust
Originated  Preferred  Securities due April 30, 2037. The proceeds from the sale
of these  securities  were used by PSO to repay  short-term  debt,  to reimburse
PSO's treasury for the cost of reacquiring  approximately $14.5 million of 4.00%
Series and 4.24% Series  preferred  stock,  to provide  working  capital and for
other general corporate purposes.  Settlement of the transaction occurred on May
2, 1997.  PSO Capital I is treated as a subsidiary  of PSO whose only assets are
the approximately $77.3 million principal subordinated debentures issued by PSO.

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In addition to PSO's obligation under the subordinated debentures,  PSO has also
agreed  to a  security  obligation  which  represents  a full and  unconditional
guarantee of PSO Capital I's trust obligations.

      On April 30, 1997,  SWEPCO's  business  trust,  SWEPCO  Capital I, sold to
underwriters  in a negotiated  offering  $110  million,  7.875%  Series A, Trust
Preferred  Securities  due April 30, 2037.  The proceeds  from the sale of these
securities were used by SWEPCO to repay short-term  debt, to reimburse  SWEPCO's
treasury  for the  cost of  reacquiring  approximately  $15.5  million  of 4.28%
Series,  4.65% Series, 5.00% Series and 6.95% Series preferred stock, to provide
working  capital and for other  general  corporate  purposes.  Settlement of the
transaction occurred on May 8, 1997. SWEPCO Capital I is treated as a subsidiary
of SWEPCO  whose only  assets are the  approximately  $113.4  million  principal
subordinated  debentures  issued by SWEPCO.  In addition to SWEPCO's  obligation
under  the  subordinated  debentures,  SWEPCO  has  also  agreed  to a  security
obligation which represents a full and unconditional guarantee of SWEPCO Capital
I's trust obligations.

      On May 8, 1997,  CPL's business trust, CPL Capital I, sold to underwriters
in a negotiated  offering $150  million,  8.00% Series A,  Cumulative  Quarterly
Income  Preferred  Securities  due April 30, 2037. The proceeds from the sale of
these  securities were used by CPL to repay  short-term debt, to reimburse CPL's
treasury  for the  cost of  reacquiring  approximately  $87.5  million  of 4.00%
Series,  4.20% Series, 7.12% Series and 8.72% Series preferred stock, to provide
working  capital and for other  general  corporate  purposes.  Settlement of the
transaction  occurred on May 14, 1997.  CPL Capital I is treated as a subsidiary
of CPL  whose  only  assets  are  the  approximately  $154.6  million  principal
subordinated debentures issued by CPL. In addition to CPL's obligation under the
subordinated  debentures,  CPL has also  agreed to a security  obligation  which
represents  a  full  and  unconditional  guarantee  of  CPL  Capital  I's  trust
obligations.

      In March 1997, an affiliate of Orange Cogeneration Limited Partnership, an
entity  that is 50%  indirectly  owned by CSW  Energy and  accounted  for by the
equity method of accounting,  issued $110 million,  8.175% Senior Secured Bonds,
due 2022.  The  bonds  are  unconditionally  guaranteed  by Orange  Cogeneration
Limited Partnership.  Concurrently,  $53.2 million was distributed to CSW Energy
representing its equity investment in the Orange Cogeneration project.

      Short-Term Financing and Accounts Receivable Factoring The CSW System uses
      short-term debt, primarily commercial paper, to meet
fluctuations  in working capital  requirements  and other interim capital needs.
CSW has established a system money pool to coordinate  short-term borrowings for
certain of its subsidiaries, primarily the U.S. Electric Operating Companies. In
addition,  CSW  also  incurs  borrowings  for  other  subsidiaries  that are not
included in the money pool. As of December 31, 1997, CSW had a revolving  credit
facility  totaling  $1.4 billion to back up its  commercial  paper  program.  At
December 31, 1997 CSW had $721 million outstanding in short-term borrowings. The
maximum amount of short-term borrowings outstanding during the year, which had a
weighted  average  interest  yield for the year of 5.8%, was $725 million during
December 1997.

      CSW Credit  purchases,  without recourse,  the accounts  receivable of the
U.S. Electric Operating Companies and certain non-affiliated electric companies.
The sale of accounts  receivable  provides the U.S. Electric Operating Companies
with cash  immediately,  thereby  reducing  working  capital  needs and  revenue
requirements.  In addition,  CSW Credit's  capital  structure  contains  greater
leverage than that of the U.S. Electric  Operating  Companies,  so CSW's cost of
capital is lowered.  CSW Credit  issues  commercial  paper to meet its financing
needs.  At December 31, 1997,  CSW Credit had a $900  million  revolving  credit
agreement,  secured  by  the  assignment  of its  receivables,  to  back  up its
commercial paper program, which had $637 million outstanding. The maximum amount
of such  commercial  paper  outstanding  during  the year,  which had a weighted
average interest yield of 5.6%, was $890 million during September 1997.

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      CSW has recently made several  finance-related  filings with the SEC under
the Holding  Company Act which,  if approved,  would  increase  CSW's  financial
flexibility.  In the first filing,  CSW requested  authority to repurchase up to
ten percent of its outstanding  common stock as of June 30, 1997, from its stock
and employee  benefit plans (pursuant to the terms and conditions of such plans)
from time to time  through  December  31,  2002,  and to utilize its  short-term
borrowing  program,  including  funds  borrowed  through  its  commercial  paper
program, to finance its repurchase in the open market of up to twenty percent of
its  outstanding  common stock as of June 30, 1997. No decision  regarding  this
application  has been  made by the SEC.  Such  authority  would  increase  CSW's
flexibility  to  adjust  its  capital  structure.  The  second  filing  requests
authority  through  December  31,  2002 for CSW,  the  U.S.  Electric  Operating
Companies and CSW Services to finance ongoing  business,  repay  short-term debt
and  finance  the  potential  repurchase  of  outstanding  securities.  CSW  has
requested  authority to issue common stock,  while the U.S.  Electric  Operating
Companies  and CSW Services  have  requested  authority  to issue common  stock,
preferred  stock and debt. Such authority would give CSW the flexibility to take
advantage of favorable market conditions for routine financings.  The SEC issued
an order on December 30, 1997 granting the requested authority. The third filing
requests an increase in the authorized short-term borrowing capacity for CSW and
certain of its  subsidiaries.  The SEC has not  issued an order with  respect to
this application.  For a description of certain restrictions on CSW's ability to
repurchase common stock and to raise capital from external sources, see PROPOSED
AEP MERGER.

      CSW Energy and CSW International
      In October 1996,  CSW Energy issued $200 million,  6.875% Senior Notes due
2001.  The proceeds  from the notes were for the  acquisition,  development  and
construction  of  electric  generation  assets in the United  States and to make
affiliate loans to CSW International.

      CSW Energy has  authority  from the SEC to expend up to $250  million  for
general development  activities related to qualifying facilities and independent
power  facilities.  CSW Energy may seek specific  authority to spend  additional
amounts on certain projects  subject to limitations  contained in the AEP merger
agreement. See NOTE 3. COMMITMENTS AND CONTINGENT LIABILITIES,  for a discussion
of CSW's  investments  and  commitments  in CSW Energy  projects at December 31,
1997.

      In January  1997,  CSW received  authority  from the SEC under the Holding
Company Act to spend an amount up to 100% of consolidated  retained  earnings on
EWG or FUCO  investments.  This  represents an increase in authority  previously
granted  under  the  Holding  Company  Act.  However,  the  amount  of any  such
expenditures is subject to the terms of the AEP merger agreement. As of December
31,  1997,  CSW had  invested an amount  equal to 49% of  consolidated  retained
earnings,  as defined by rule 53 of the  Holding  Company  Act,  on EWG and FUCO
investments. For a description of certain restrictions on the ability of CSW and
its  subsidiaries  to  make  capital   expenditures  in  respect  of  qualifying
facilities  and  independent   power   facilities  and  to  make  EWG  and  FUCO
investments, see PROPOSED AEP MERGER.


RECENT DEVELOPMENTS AND TRENDS

      CSW Strategic Responses
      CSW has,  from time to time  considered,  and  expects to  consider in the
future, various strategies designed to enhance CSW's competitive position and to
increase its ability to anticipate and adapt to changes in the electric  utility
industry.   These  strategies  may  include  business  combinations  with  other
companies,  internal restructurings involving the complete or partial separation
of CSW's generation,  transmission and distribution businesses,  acquisitions or
dispositions  of assets or lines of business,  and additions to or reductions of
franchised service territories. CSW may from time to time engage in discussions,
either  internally  or with  third  parties,  regarding  one or  more  of  these
potential  strategies.  Those  discussions  may be  subject  to  confidentiality
agreements and CSW's policy is generally not to comment on such  activities.  No
assurances  can be given that any potential  transaction  of the type  described
above may actually occur,  or, if one does occur, the ultimate effect thereof on

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<PAGE>

CSW's results or operations,  financial  condition or competitive  position (The
foregoing  statement  constitutes a forward looking statement within the meaning
of Section 21E of the Exchange Act.  Actual results may differ  materially  from
such projected  information  due to changes in the underlying  assumptions.  See
FORWARD LOOKING INFORMATION).

      AEP Merger
      In December  1997,  AEP and CSW  announced  that their boards of directors
approved a definitive merger agreement. If the merger is completed, the combined
company will be a  diversified  electric  utility  serving more than 4.6 million
customers in 11 states and  approximately 4 million customers outside the United
States.  On January 19,  1998,  CSW  announced a corporate  realignment  to more
effectively  position itself for competition and to better align itself with AEP
related  to the  proposed  merger of the two  companies.  The  transaction  must
receive regulatory  approval from federal and state authorities and must satisfy
a number of other  conditions,  some of which,  such as CSW and AEP  shareholder
approval,  may not be waived by the parties.  There can be no assurance that the
AEP Merger will be consummated, and if it is, the timing of such consummation or
the  effect  of  any  regulatory   conditions   that  may  be  imposed  on  such
consummation. See PROPOSED AEP MERGER.

      Competition and Industry Challenges
      Competitive  forces at work in the electric utility industry are impacting
the CSW System and electric utilities  generally.  Increased  competition facing
electric  utilities is driven by complex  economic,  political and technological
factors.  These factors have resulted in legislative and regulatory  initiatives
that are likely to result in even greater  competition at both the wholesale and
retail levels in the future. As competition in the industry increases,  the U.S.
Electric Operating Companies will have the opportunity to seek new customers and
at  the  same  time  be at  risk  of  losing  customers  to  other  competitors.
Additionally,  the U.S.  Electric  Operating  Companies will continue to compete
with suppliers of alternative forms of energy, such as natural gas, fuel oil and
coal, some of which may be cheaper than electricity.  In the United Kingdom, the
franchised  electricity supply business is scheduled to open to full competition
on a phased-in basis on September 1, 1998. As a result, SEEBOARD will be able to
seek  customers   while  risking  the  loss  of  existing   customers  to  other
competitors.  As a whole, the CSW U.S.  Electric System believes that,  overall,
its prices for  electricity  and the  quality  and  reliability  of its  service
currently  place  it  in  a  position  to  compete  effectively  in  the  energy
marketplace  (The foregoing  statement  constitutes a forward looking  statement
within the meaning of Section 21E of the Exchange Act. Actual results may differ
materially  from such  projected  information  due to changes in the  underlying
assumptions. See FORWARD LOOKING INFORMATION).  See RATES AND REGULATORY MATTERS
for a discussion of several current issues impacting the CSW System.

      Electric industry  restructuring and the development of competition in the
generation and sale of electric power requires  resolution of several  important
issues,  including,  but not  limited to: (i) who will bear the costs of prudent
utility   investments   or   past   commitments   incurred   under   traditional
cost-of-service regulation that will be uneconomic in a competitive environment,
sometimes  referred to as stranded costs; (ii) whether all customers have access
to the benefits of competition; (iii) how, and by whom, the rules of competition
will  be  established;   (iv)  what  the  impact  of  deregulation  will  be  on
conservation, environmental protection and other regulator-imposed programs; and
(v) how transmission  system reliability will be ensured.  The degree of risk to
CSW associated with various federal and state  restructuring  proposals aimed at
resolving  any or all of these  issues  will  vary  depending  on many  factors,
including the proposals'  competitive position and treatment of stranded utility
investment  resulting from such  requirements.  Although CSW believes it is in a
position to compete effectively in a deregulated,  more competitive marketplace,
if stranded costs are not recovered from customers,  then CSW may be required by
existing accounting standards to recognize  potentially  significant losses from
unrecovered  stranded  costs,  especially  with  respect  to STP (The  foregoing
statement  constitutes a forward looking statement within the meaning of Section
21E of the  Exchange  Act.  Actual  results  may  differ  materially  from  such
projected information due to changes in the underlying assumptions.  See FORWARD
LOOKING INFORMATION). See Regulatory Accounting for additional information.

                                       7
<PAGE>

      At the federal level, several bills were introduced in Congress during the
1997 legislative  session which provided for restructuring  and/or  deregulating
the electric utility industry.  However, no such bills were enacted into law. In
1998, the United States Senate has progressed  further in its  consideration  of
comprehensive energy  restructuring  legislation than the United States House of
Representatives.  However,  in the  United  States  Senate,  differences must be
resolved  between those who favor  legislation to repeal the Holding Company Act
and those who support repeal only in the context of  comprehensive  legislation.
Prospects for repeal of the Holding Company Act in 1998 are unclear.

      While a majority  of the  states,  including  the four states in which the
U.S. Electric  Operating  Companies operate,  have considered  deregulation that
requires some form of retail  competition,  several  states have enacted  actual
legislation  mandating  retail  competition  including  Oklahoma  in  which  PSO
operates.  CSW cannot  predict  when and if it will be subject to one or more of
these  legislative  initiatives,  nor can it predict the scope or effect of such
legislation on its results of operations or financial condition.  For additional
information  related  to such  state  initiatives,  see  Industry  Restructuring
Initiatives in Texas, Louisiana, Oklahoma and Arkansas.

      Wholesale Electric Competition in the United States
      The Energy Policy Act,  which was enacted in 1992,  significantly  altered
the way in which  electric  utilities  compete.  The Energy  Policy Act  created
exemptions from regulation under the Holding Company Act and permits  utilities,
including registered utility holding companies and non-utility companies, to own
EWGs.  EWGs  are a  relatively  new  category  of  non-utility  wholesale  power
producers  that are free  from most  federal  and  state  regulation,  including
restrictions  under the Holding  Company Act.  These  provisions  enable broader
participation in wholesale power markets by reducing  regulatory hurdles to such
participation.  The Energy  Policy Act also allows the FERC,  on a  case-by-case
basis and with certain restrictions,  to order wholesale transmission access and
to order electric utilities to enlarge their transmission  systems. A FERC order
requiring a transmitting utility to provide wholesale  transmission service must
include  provisions  generally  that permit the utility to recover from the FERC
applicant all of the costs incurred in connection with the transmission services
and  any  enlargement  of  the  transmission  system  and  associated  services.
Wholesale  energy  markets,  including the market for wholesale  electric power,
have been increasingly competitive since enactment of the Energy Policy Act. The
U.S. Electric  Operating  Companies must compete in the wholesale energy markets
with other  public  utilities,  cogenerators,  qualifying  facilities,  EWGs and
others for sales of electric  power.  While CSW believes  that the Energy Policy
Act will continue to make the wholesale markets more competitive,  CSW is unable
to predict whether the Energy Policy Act will adversely impact the U.S. Electric
Operating Companies.

      FERC Orders 888 and 889
      The FERC issued Order No. 888 in 1996,  which is the final comparable open
access  transmission  service rule. The provisions of FERC Order No. 888 provide
for comparable  transmission  service between  utilities and their  transmission
customers by requiring  utilities to take transmission  service under their open
access tariffs for wholesale  sales and purchases and by requiring  utilities to
rely on the same transmission information that their transmission customers rely
on to make wholesale purchases and sales.

      In addition,  the Texas Commission  adopted a rule governing  transmission
access and pricing for ERCOT in 1996.  The pricing  method  adopted by the Texas
Commission is a hybrid  combination of an ERCOT-wide postage stamp rate covering
70% of total ERCOT transmission costs and a  distance-sensitive  component which
recovers the  remaining  30% of ERCOT's  transmission  costs.  CPL and WTU began
recording  transmission  revenues  and  expenses  in  accordance  with the Texas
Commission's rule on January 1, 1997.

FERC  Order  No.  888  requires   holding   companies  to  offer  single  system
transmission  rates.  The  transmission  rates of the U. S.  Electric  Operating
Companies  are  under  the  exclusive   jurisdiction   of  the  FERC  while  the
transmission rates of most of the transmitting  utilities in ERCOT are under the
exclusive jurisdiction of the Texas Commission. Because the two commissions have
different  approaches  to  defining  and  implementing  comparable  open  access
transmission  service,  Order  No.  888  granted  the U. S.  Electric  Operating

                                       8
<PAGE>

Companies an exemption permitting them an opportunity to propose a solution that
provides  comparability  to all wholesale  users. On November 1, 1996, the U. S.
Electric Operating Companies filed a system-wide tariff to comply with Order No.
888 and, on December 31,  1996,  the FERC  accepted  for filing the  system-wide
tariff which became  effective on January 1, 1997,  subject to refund and to the
issuance of further orders.

      On December 10, 1997 the FERC issued an order regarding the U. S. Electric
Operating  Companies' proposed system-wide tariff filed on November 1, 1996. The
FERC's  order  accepted the proposed  tariff  subject to several  modifications,
including  revisions to provide for  system-wide  transmission  service  under a
single system rate. The U. S. Electric  Operating  Companies  filed the required
compliance  tariff on February 9, 1998 and are waiting for FERC's  acceptance of
the revised tariff.

      In 1996, the FERC issued Order No. 889 requiring transmitting utilities to
establish and operate an OASIS for the  dissemination  of information  regarding
available transfer  capability for their respective  transmission  systems.  The
OASIS is an on-line  information system that provides the same information about
the  utility's  transmission  system  to all  transmission  customers.  The U.S.
Electric Operating  Companies utilize,  and participate in the OASIS systems for
ERCOT  and SPP.  Order No.  889 also  created  standards  of  conduct  requiring
utilities to conduct any wholesale  power sales business  separately  from their
transmission  operations.  The  standards of conduct are designed to ensure that
utilities and their  affiliates,  as sellers of power, do not have  preferential
access to information about wholesale transmission prices and availability.

      Retail Electric Competition in the United States
      Increased  competition  in the utility  industry has resulted in increased
pressure to stabilize or reduce  rates.  The retail  regulatory  environment  is
beginning  to  shift  from   traditional   rate  base  regulation  to  incentive
regulation.  Incentive rate and performance-based  plans encourage  efficiencies
and increased  productivity while permitting  utilities to share in the results.
Retail wheeling, a major legislative initiative which would require utilities to
"wheel"  or move power from  third  parties  to their own retail  customers,  is
evolving  gradually.  Most states  either  have  introduced  legislation  or are
investigating  the issue,  and several  states have already  passed  legislation
which mandates retail choice by a certain date.

      CSW believes that retail competition would not be in the best interests of
CSW's  security  holders  unless CSW receives  fair recovery of the full amounts
previously  invested to finance  power  plants.  These  investments,  which were
reasonably incurred,  were made by the U.S. Electric Operating Companies to meet
their obligation to serve the public interest,  necessity and convenience.  This
obligation  has existed for nearly a century and remains in force under  current
law.  CSW  intends to strongly  oppose  attempts  to impose  retail  competition
without just  compensation  for the risks and investments CSW undertook to serve
the public's  demand for  electricity.  For  additional  information  related to
retail  wheeling in the United States,  see Holding  Company Act and Legislative
Update and Industry Restructuring Initiatives in Texas, Louisiana,  Oklahoma and
Arkansas.

      Industry Restructuring Initiatives in Texas, Louisiana, Oklahoma and
Arkansas
      Several initiatives regarding  restructuring the electric utility industry
have  recently  been  undertaken  in the four states in which the U.S.  Electric
Operating   Companies  operate.   Legislation  was  enacted  in  Oklahoma  while
legislative activity in Texas,  Louisiana and Arkansas stopped short of any such
definitive action.

      In April 1997, the Oklahoma  Legislature  enacted legislation dealing with
industry  restructuring  in Oklahoma,  which provides for retail  competition by
July 1, 2002.  The  legislation  directs the  Oklahoma  Commission  to study all
relevant  issues  relating  to  restructuring  and  develop  a  framework  for a
restructured industry. The legislation divides the study of restructuring issues
by the Oklahoma  Commission  into four parts:  (i)  independent  system operator
issues; (ii) technical issues; (iii) financial issues; and (iv) consumer issues.
At the end of each of  these  studies,  the  Oklahoma  Commission  must  provide
reports along with  legislative  recommendations.  The  legislation  directs the
Oklahoma Tax Commission to study the impact of electric utility restructuring on
state tax revenues and the existing tax structure, consider the establishment of

                                       9
<PAGE>

a uniform  consumption  tax, and report to the Oklahoma  Legislature by December
31, 1998. The  legislation  prohibits the  establishment  of retail  competition
until a uniform tax policy is established.  The legislation also creates a Joint
Electric  Utility Task Force,  a 14-member  panel composed of an equal number of
representatives from the Oklahoma United States House of Representatives and the
Oklahoma  Senate.  The  duties of this task  force  include  the  oversight  and
direction  of the  studies  by the  Oklahoma  Commission  and the  Oklahoma  Tax
Commission.  Management  is unable to predict  the  outcome of these  studies or
their ultimate impact on CSW's results of operations and financial.

      In March 1997,  the Arkansas  Legislature  passed a  resolution  directing
interim  legislative  committees  to study  competition  in the  electric  power
industry in Arkansas.  The study began in October 1997, and the committees  will
continue to hold hearings  throughout  1998.  Also, the Arkansas  Commission has
initiated a series of generic  restructuring  dockets.  The Arkansas  Commission
will provide a report to the Arkansas Legislature by October 1998. In Louisiana,
a special legislative  committee created by the Louisiana Senate is studying the
impact of  retail  competition  on the  state of  Louisiana.  The  committee  is
scheduled  to issue a report  before the next regular  session of the  Louisiana
Legislature.  The  Louisiana  Commission  has also opened a proceeding  to study
restructuring and retail  competition.  In Texas, the Texas Lieutenant  Governor
appointed  a  Senate  interim   committee  to  study  retail   competition   and
restructuring. The committee is holding a series of hearings and is scheduled to
issue a report by September 1998.  Management  cannot predict the outcome of the
studies  in  Arkansas,  Louisiana  and Texas or their  ultimate  impact on CSW's
results of operations and financial condition.

      Industry Restructuring in Texas
      Amendments to PURA, the legal foundation of electric  regulation in Texas,
became  effective on  September  1, 1995.  Among other  things,  the  amendments
deregulate the wholesale bulk power market in ERCOT,  permit pricing flexibility
for  utilities  facing  competitive  challenges,  provide  for  a  market-driven
integrated   resource  planning  process  and  mandate  comparable  open  access
transmission service.

      PURA also  required that the Texas  Commission  adopt a rule on comparable
open  transmission  access by March 1, 1996. In conjunction with this rulemaking
proceeding  (Project No. 14045),  the chairman of the Texas Commission  issued a
proposal on September 6, 1995, for the purpose of maximizing  competition in the
ERCOT  wholesale  bulk  power  market.  The  proposal  calls for the  functional
unbundling of integrated  utilities where  distribution  entities could purchase
their power requirements from any generator or set of generators in ERCOT. Those
generators which are currently  regulated would be deregulated  after provisions
are in place to recover  stranded  costs.  The  proposal was assigned a separate
proceeding  (Project No.  15000),  and after a series of workshops and technical
conferences  conducted during 1996, the Texas Commission submitted a final Scope
of Competition report to the Texas Legislature in January 1997. The final report
contains numerous  recommendations  to the Texas Legislature  including requests
for  additional  regulatory  authority or  clarification  of existing  authority
including to  certificate  electric  service  resellers,  the authority to adopt
consumer protection and universal service standards,  the authority to determine
and  allocate  stranded  costs  to  all  customers,  the  authority  to  promote
unbundling,  the authority to allow alternative  forms of regulation,  increased
authority  to  address  mergers,  authority  to  correct  market  power  abuses,
authority  over the ERCOT ISO and  authority to permit  alternative  methods for
fuel cost recovery.  In addition,  the final report offers the Texas Legislature
four restructuring options. Option 1 maintains the regulatory status quo; Option
2 would permit  utilities to  voluntarily  offer retail  access;  Option 3 would
provide  for full  wholesale  competition;  and Option 4 would  provide for full
retail  competition.   The  report's  final  recommendation  is  for  the  Texas
Legislature  to  direct  the  Texas   Commission  to  prepare  for  full  retail
competition  using a  careful  and  deliberate  approach  on a  timetable  to be
established by the Texas Legislature,  but with no retail access before the year
2000. The Texas  legislature  considered but did not pass any of these proposals
in the 1997 legislative session.

      On  February  7,  1996,  the Texas  Commission  adopted  a rule  governing
transmission  access and pricing (Project No. 14045). The pricing method adopted
by the Texas Commission is a hybrid  combination of an ERCOT-wide  postage stamp
rate  covering 70% of total ERCOT  transmission  costs and a  distance-sensitive

                                       10
<PAGE>

component  referred to as a  vector-absolute  megawatt  mile which  recovers the
remaining 30% of ERCOT  transmission  costs.  The open access tariffs filed with
the FERC on February 9, 1996 did not reflect Project No. 14045 pricing. However,
on November 1, 1996,  CSW filed  tariffs with the FERC in  accordance  with FERC
Order 888 that conform to the Texas  Commission's  rule. See FERC Orders 888 and
889  for  additional   information  regarding  the  transmission  pricing  rules
prescribed by FERC.

      By statute  the Texas  Commission  was  required to submit a report to the
1997 Texas  Legislature on "methods or procedures for  quantifying the magnitude
of stranded  investment,  procedures  for allocating  costs,  and the acceptable
methods of recovering  stranded costs." The Texas Commission  initiated  Project
No. 15001 to collect  information to prepare the required report. In response to
the Texas  Commission's  order in Project 15001, CPL, SWEPCO, and WTU each filed
information on estimates of potential  stranded costs. While the filings for CPL
included  estimates of  significant  potential  stranded  costs,  no significant
potential  stranded  costs were  identified in the filings for SWEPCO or WTU. In
January  1998,  the Texas  Commission  requested  updated  information  on CPL's
stranded  costs for a report  that the Texas  Commission  is  preparing  for the
Senate interim committee on restructuring. See NOTE 2. LITIGATION AND REGULATORY
PROCEEDINGS for a discussion of the potential impact of potential stranded costs
relating to CPL.

      The Texas Commission's  Project 15002, "Scope of Competition Report," is a
report that the Texas Commission is required to present to the Texas Legislature
in each  odd-numbered  year  detailing the scope of  competition in the electric
markets and the impact of competition and industry  restructuring  on customers.
In  addition,   the  report  is  required  to  include  the  Texas  Commission's
recommendations to the Texas Legislature for further legislation.  In June 1996,
CPL, SWEPCO and WTU each filed information for the Texas Commission's report.

      Texas Independent System Operator Plan
      In June 1996, CSW,  including CPL and WTU, and more than 20 other parties,
including other investor-owned  utilities,  municipal power companies,  electric
cooperatives,  independent  power producers and power marketers,  filed plans to
create an ISO to manage the ERCOT  power  grid.  The  filing  marks a major step
towards  implementing  the Texas  Commission's  overall  strategy  to create the
competitive wholesale electric market that was mandated by the Texas Legislature
in 1995.  The Texas  Commission  approved the ISO in August 1996.  Such approval
made Texas the first state in the nation to adopt a plan for a regional  ISO and
a regional competitive wholesale bulk power market.

      Integrated Resource Plan
      In January 1997,  CPL,  WTU, and SWEPCO filed with the Texas  Commission a
joint  integrated  resource plan outlining the companies'  future electric needs
over a 10-year forecast horizon and the manner in which the companies propose to
meet those needs. In July 1997 the Texas  Commission  issued an Interim Order on
the Preliminary Plan which adopted a settlement  agreement that had been reached
with all the parties in the case.  The Interim Order  approved the load forecast
and individual resource needs for each of the companies,  as well as the request
for proposal  documents to be used to procure future resource needs. The Interim
Order also approved the targeted  purchase goal amounts for renewable and energy
efficiency  programs,  which will  result in  renewable  and  energy  efficiency
programs being included in the  companies'  resource mix. The targeted  purchase
goals were  developed  in  response  to  customer  input  obtained  through  the
deliberative  polling process  conducted at each operating company in the summer
of 1996. A separate phase of the Integrated Resource Plan was created to address
the value of  interruptible  resources  at CPL.  That  phase is  expected  to be
completed in March 1998.  The Interim  Order also  required that a green pricing
tariff be filed which would allow  customers  who are  interested in acquiring a
greater portion of their personal  consumption from  environmentally  beneficial
generation to exercise that choice.  A green pricing tariff was approved for use
in San  Angelo,  Texas in October  1996.  A  system-wide  filing is  expected in
mid-1998.

                                       11
<PAGE>

      Holding Company Act and Legislative Update
      The  Holding  Company  Act  generally  has been  construed  to  limit  the
operations of a registered holding company to a single integrated public utility
system,  plus such  additional  businesses as are  functionally  related to such
system.  Among other  things,  the  Holding  Company  Act  requires  CSW and its
subsidiaries   to  seek  prior  SEC  approval  before   effecting   mergers  and
acquisitions or pursuing other types of non-utility initiatives.  Such pervasive
regulation  may  impede or delay  CSW's  efforts to achieve  its  strategic  and
operating objectives.  Consequently,  CSW continues to support efforts to repeal
or modify this legislation.

      In 1995, the SEC issued a report to the United States Congress  advocating
repeal of the Holding  Company Act,  either on a  conditional  and  transitional
basis or immediate and outright repeal.  The basis for the SEC's  recommendation
for repeal is that the Holding Company Act is  anachronistic  and duplicative of
other federal and state  regulatory  regimes that have  developed  over the past
sixty years.  Following the SEC's report, there were several bills introduced in
both the United States Senate and House of  Representatives  in 1996 which would
have repealed the Holding  Company Act on a conditional and  transitional  basis
and transferred its oversight functions to the FERC and the states. Another bill
was introduced into the United States House of Representatives that, in addition
to repealing the Holding  Company Act,  would have repealed  PURPA,  which among
other  things,  requires  investor  owned  utilities to purchase  power at their
avoided  cost from  qualifying  facilities.  Although  none of these  bills were
enacted into law, they may suggest the form of future legislation.

      In  January  1997,  a bill was  introduced  in the  United  States  Senate
providing for  comprehensive  electric  utility industry  restructuring  and for
retail choice by December 2003, repeal of the Holding Company Act one year after
the  bill is  enacted,  as well  as  repeal  of the  requirement  that  electric
utilities purchase power at their avoided cost from qualifying  facilities under
PURPA.  Under this bill,  many of the oversight  functions  performed by the SEC
under the Holding  Company  Act would be shifted to the FERC and the states.  In
addition,  a bill was reintroduced in the United States House of Representatives
providing  for choice of  electricity  suppliers at the retail level by the year
2000.  Under  this bill,  which is  substantially  similar to the United  States
Senate bill, the application of the Holding Company Act to a particular  holding
company  system  would be  eliminated  after each state  served by the  electric
utility  companies in that system made a determination  that retail  competition
existed in that state.
No legislation was enacted in 1997.

      In  February  1997,  the SEC adopted  Rule 58  allowing a holding  company
registered under the Holding Company Act or any of its subsidiaries, to acquire,
without prior SEC approval, the securities of any energy-related company subject
to certain  limits.  Under the new rule,  investment in  energy-related  company
securities  without  prior SEC  approval  is limited  to the  greater of (i) $50
million  and  (ii)  15% of the  consolidated  capitalization  of the  registered
holding  company as  reported on its most recent Form 10-Q or Form 10-K as filed
with the SEC. Rule 58 does not exempt the  acquisition  by a registered  holding
company of the  securities  of an  electric  utility  company  or a gas  utility
company,  which remains subject to the SEC's prior approval as does the issuance
of securities for the purpose of making such exempt investments.

      In  1998,  the  United  States  Senate  has  progressed   further  in  its
consideration of comprehensive energy restructuring  legislation than the United
States  House  of  Representatives.   However,  in  the  United  States  Senate,
differences must be resolved  between those who favor  legislation to repeal the
Holding  Company  Act and  those  who  support  repeal  only in the  context  of
comprehensive  legislation.  Prospects for repeal of the Holding  Company Act in
1998 are unclear.

      Regulatory Accounting
      Consistent with industry practice and the provisions of SFAS No. 71, which
allows for the recognition and recovery of regulatory  assets, the U.S. Electric
Operating   Companies  have  recognized   significant   regulatory   assets  and
liabilities.  Management  believes that the U.S.  Electric  Operating  Companies
currently meet the criteria for following SFAS No. 71. However, in the event the
U.S.  Electric  Operating  Companies or some portion of their business no longer
meets the criteria for following  SFAS No. 71 due to  deregulation  or for other
reasons,  a write-off of regulatory  assets and  liabilities  would be required,
absent a means of  recovering  such assets or  settling  such  liabilities  in a

                                       12
<PAGE>

continuing  regulated  segment  of  the  business.  For  additional  information
regarding regulatory  accounting,  reference is made to NEW ACCOUNTING STANDARDS
and NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.

      PSO Union Negotiations
      As previously reported, PSO and its Local Union 1002 of the IBEW have been
engaged in contract renewal  negotiations.  The underlying  agreement expired in
September 1996 and, to date, the parties have been unable to reach an agreement.
In December 1996, PSO implemented portions of its final proposal after declaring
an  impasse.  The  principal  issue  of  disagreement  involves  PSO's  need for
flexibility in a deregulated environment.

      In April 1997,  Oklahoma's  governor signed into law an electric  industry
restructuring   bill.  The  new  law  mandates  the   implementation  of  retail
competition  to begin on July 1, 2002.  PSO believes that the new law also broke
the impasse in the contract  negotiations and has resumed  negotiations with the
union. At this time, PSO cannot predict the outcome of this matter. However, PSO
believes  that,  even in the event of a strike,  its  operations  would continue
without a  significant  disruption  and that a strike  would not have a material
adverse  effect on CSW's  results of  operations  or  financial  condition  (The
foregoing  statement  constitutes a forward looking statement within the meaning
of Section 21E of the Exchange Act.  Actual results may differ  materially  from
such projected  information  due to changes in the underlying  assumptions.  See
FORWARD LOOKING INFORMATION).

     Impact of Competition  and Industry  Restructuring  Initiatives 
     CSW is unable to predict the  ultimate  outcome or impact of  competitive
forces on the electric utility industry in the United States,  and in the United
Kingdom  or  on  the  CSW  System.  As  the  electricity   markets  become  more
competitive,  however,  theprincipal  factor determining success is likely to be
price,  and to a  lesser  extent  reliability,  availability  of  capacity,  and
customer service.  CSW cannot predict the form or effect of any federal or state
electric utility  restructuring  initiatives at this time.  Federal and/or state
electric  utility  restructuring  may cause  impairment of significant  recorded
assets,  material  reductions  of  profit  margins,  and/or  increased  costs of
capital.  No  assurance  can be made that such events  would not have a material
adverse  effect  on  CSW's  results  of  operations,   financial   condition  or
competitive  position (The  foregoing  statement  constitutes a forward  looking
statement  within the meaning of Section 21E of the Exchange Act. Actual results
may differ  materially  from such  projected  information  due to changes in the
underlying assumptions. See FORWARD LOOKING INFORMATION).

RATES AND REGULATORY MATTERS

      CPL Rate Review - Docket No. 14965
      In  November  1995,  CPL filed  with the  Texas  Commission  a request  to
increase its retail base rates by $71 million, and in May 1996, CPL placed a $70
million base rate  increase  into effect under bond,  subject to refund based on
the  receipt of the CPL 1997  Original  Rate Order of the Texas  Commission.  On
March 31, 1997, the Texas  Commission  issued a rate order in CPL's rate review,
Docket No. 14965.  Thereafter,  CPL filed a motion for rehearing which requested
the reconsideration of numerous  provisions of the order.  Motions for rehearing
were also filed by other  parties to the rate  proceeding.  In  response  to the
motions  for  rehearing,  in  June  1997,  the  Texas  Commission  made  several
modifications  to the CPL 1997  Original Rate Order and also agreed to rehear on
remand  several  other  issues.  CPL restored  its rates in July 1997,  with two
exceptions,  to levels existing prior to the May 1996  implementation  of bonded
rates. On August 21, 1997, after  reconsidering the issues on remand,  the Texas
Commission  voted to issue a revised final order and on September 10, 1997,  CPL
received a revised  final order.  CPL filed its second  motion for  rehearing on
September  30,  1997.   The  second  motion  for   rehearing   again   requested
reconsideration  of numerous  issues in the rate case. On October 16, 1997,  the
Texas  Commission  issued the CPL 1997  Final  Order.  The CPL 1997 Final  Order
lowers the annual  retail base rates of CPL by  approximately  $19  million,  or
2.5%,  from CPL's rate level existing  prior to May 1996.  The Texas  Commission

                                       13
<PAGE>

also  included a "Glide  Path"  rate  methodology  in the CPL 1997  Final  Order
pursuant  to which  CPL's  annual  rates will be reduced  by an  additional  $13
million in mid-1998 and another $13 million in mid-1999.

      There are numerous  contributing factors to the difference between the $71
million  retail  base  rate  increase  originally  requested  by CPL and the $19
million retail base rate reduction included in the CPL 1997 Final Order. The CPL
1997 Final Order  decreased  CPL's  requested  return on equity of 12.25% on its
retail rate base to a 10.9% return on equity for all non-ECOM  invested capital,
which  results in a $30  million  decrease in CPL's rate  request.  The CPL 1997
Final  Order  provides  for the  disallowance  of  approximately  $18 million of
affiliate  transactions.  In  addition,  the CPL 1997 Final Order  denied  CPL's
request to use straight line  amortization for CPL's deferred  accounting costs.
Instead,  the CPL 1997 Final Order  requires CPL to continue to use the mortgage
amortization  method to amortize its deferred  accounting costs,  resulting in a
reduction of $14 million from CPL's rate request.  The CPL 1997 Final Order also
decreased depreciation by $17.4 million from CPL's rate request.

      Another  major  provision  of the CPL  1997  Final  Order  was  the  Texas
Commission's  categorization of $800 million of CPL's investment in STP as ECOM.
The term ECOM has been used to refer to the  amount  of costs  that  potentially
would become "stranded" if retail  competition were mandated and prices were set
in the  market,  rather than the price being  determined  by current  regulatory
standards of reasonable  and necessary cost of providing  service.  The CPL 1997
Final Order reduced CPL's equity return on the ECOM portion of CPL's  investment
in STP to 7.96%,  compared to the 10.9% return on common equity approved for all
other  invested  capital,  resulting in a $15.9  million  decrease in CPL's rate
request.  At the same time, the CPL 1997 Final Order accelerated the recovery of
the $800 million  designated as ECOM to 20 years from the remaining 32-year life
of STP.

                                       14
<PAGE>


      The  following  table  contains  details of the estimate of the  financial
impact of the CPL 1997 Final Order.
                                               1997        1998        1999
                                             ---------------------------------
                                                         (millions)

Decrease in revenue                           $(24.2)     $(28.7)     $(41.9)

Items included in decrease in revenue
  with an offsetting effect on
  expense:
      Recovery of STP (ECOM)                    20.0        20.0        20.0
      Change in depreciation                   (11.3)      (11.3)      (11.3)
      Decommissioning                            4.3         4.3         4.3
      Other                                      6.8         2.1         2.1
                                             ---------   ---------   ---------
                                                19.8        15.1        15.1
                                             ---------   ---------   ---------
Change in current year                         (44.0)      (43.8)      (57.0)
income before tax
Federal income taxes                            14.8        14.8        19.3
                                             ---------   ---------   ---------
Current year impact on net                     (29.2)      (29.0)      (37.7)
income
                                             ---------   ---------   ---------

1996 effect                                    (18.9)         --          --
                                             ---------   ---------   ---------
Estimated impact on net income                $(48.1)     $(29.0)     $(37.7)
                                             ---------   ---------   ---------

      CPL  appealed  the CPL 1997  Final  Order to the State  District  Court of
Travis  County to challenge the  resolution of several  issues in the rate case.
The primary issues include:  (i) the  classification of $800 million of invested
capital in STP as ECOM which was also  assigned  a lower  return on equity  than
non-ECOM  property,  (ii) the Texas  Commission's  use of the "Glide  Path" rate
reduction methodology to be applied to rates in mid-1998 and mid-1999, and (iii)
the $18 million of disallowed affiliate  transactions from CSW Services. As part
of the appeal, CPL seeks a temporary injunction to prohibit the Texas Commission
from  implementing  the  "Glide  Path"  rate  reduction  methodology,  currently
scheduled  to begin  in May  1998.  A  hearing  has  been set for the  temporary
injunction  on April 3,  1998.  Management  is unable to  predict  how the final
resolution  of these issues will  ultimately  affect CSW's results of operations
and financial condition.

      CPL  currently   accounts  for  the  economic  effects  of  regulation  in
accordance  with SFAS No. 71. Pursuant to the provisions of SFAS No. 71, CPL had
recorded approximately $1.3 billion of regulatory-related assets at December 31,
1997. The  application of SFAS No. 71 is conditioned  upon CPL's rates being set
based on the cost of providing service.  In the event management  concludes that
as a result of changes in regulation,  legislation, the competitive environment,
or other  factors,  including the CPL 1997 Final Order,  CPL no longer meets the
criteria for following  SFAS No. 71, a write-off of  regulatory  assets would be
required. In addition, CSW could experience,  depending on the timing and amount
of any  write-off,  a material  adverse  effect on its results of operations and
financial condition.

      The foregoing discussion of CPL Rate Review - Docket No. 14965 constitutes
forward  looking  information  within the meaning of Section 21E of the Exchange
Act. Actual results may differ materially from such projected  information.  See
FORWARD LOOKING INFORMATION.  See NOTE 2. LITIGATION AND REGULATORY  PROCEEDINGS
for additional information on the CPL 1997 Final Order.

      PSO 1997 Rate Settlement Agreement
      In July 1996, the Oklahoma Commission staff filed an application seeking a
review of PSO's  earnings.  In accordance  with the  established  schedule,  PSO
subsequently  filed financial  data,  cost of service and rate design  testimony
supporting both its current rates and an increase in annual depreciation expense
of  $26  million.  In  July  1997,  the  Oklahoma  Commission  staff  and  other
intervenors to the proceeding filed their revenue requirements testimony. In its
filing,  the Oklahoma  Commission  staff  recommended a rate  reduction of $76.8
million for PSO.

      On October 15, 1997,  PSO reached a stipulated  agreement  with parties to
settle the rate inquiry  that was pending  before the  Oklahoma  Commission.  On
October 23, 1997,  the Oklahoma  Commission  issued a final order  approving the
agreement.  The following table  represents the financial impact of the PSO 1997

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<PAGE>

Rate  Settlement  Agreement  on PSO's  1997  results of  operations  and also an
estimate of its ongoing annual impact on net income in successive years.
                                                        
                                            1997     Ongoing Annual
                                           Impact        Impact
                                        -----------   ------------
                                               (millions)
Decrease in revenue
      Refund to customers                  $(29.0)         $--
      Change in rates                        (2.5)        (35.9)
                                        -----------   ------------
                                            (31.5)        (35.9)
                                        -----------   ------------
Changes in expenses (offsetting impact
  included in revenues)
      Depreciation                           (6.3)        (10.9)
      Rate case deferred costs                2.2           --
      Income tax                            (10.2)         (8.8)
                                        -----------   ------------
                                            (14.3)        (19.7)
                                        -----------   ------------
                                            (17.2)        (16.2)
Write-off of deferred assets, net of tax    (10.2)          --
                                        -----------   ------------
                                           $(27.4)       $(16.2)
                                        -----------   ------------

      The PSO 1997 Rate  Settlement  Agreement  resulted  in a material  adverse
effect on PSO's  results  of  operations  for 1997  that will have a  continuing
material  adverse  effect  on its  results  of  operations  because  of the rate
decrease.  However,  it also reduced  significant  risks for PSO related to this
regulatory  proceeding and will enable PSO's rates to remain competitive for the
foreseeable  future.

      The foregoing discussion of PSO 1997 Rate Settlement Agreement constitutes
forward  looking  information  within the meaning of Section 21E of the Exchange
Act. Actual results may differ materially from such projected  information.  See
FORWARD LOOKING INFORMATION.  See NOTE 2. LITIGATION AND REGULATORY  PROCEEDINGS
for additional information on the PSO 1997 Rate Settlement Agreement.

      SWEPCO Louisiana Rate Review
      In December  1997,  the  Louisiana  Commission  announced  it would review
SWEPCO's rates and service.  In 1993, the Louisiana  Commission  issued an order
initiating a review of the rates of all  investor-owned  utilities in the state.
Since that time,  each of the other  investor-owned  utilities in Louisiana have
been  reviewed.  SWEPCO's last rate activity was an $8.2 million rate  decrease,
initiated by SWEPCO and approved for its small and large industrial customers in
January 1988. Prior to that, SWEPCO's last rate increase was in 1985.

      The Louisiana  Commission has requested bids from consultants to perform a
review of SWEPCO's rates and charges and to review SWEPCO's  quality of service.
The Louisiana  Commission plans to select  consultants during the second quarter
of 1998 and a timeline for the review will be determined shortly thereafter.
Management cannot predict the outcome of this review.

      SEEBOARD Recent Regulatory Actions
      Following the phased-in  opening of the United Kingdom  domestic and small
business  electricity market to competition in September 1998, customers will be
able to choose their electricity  supplier.  SEEBOARD will compete for customers
in its own area as well as throughout the rest of the United  Kingdom.  The DGES
has  allowed  some  of  the  system   development   costs  associated  with  the
introduction  of  competition  to  be  recovered  by  the  regional  electricity
companies  through a charge to all customers over the next five years.  The DGES
has also  announced  price  restraints  which set a maximum amount that existing
electricity  supply  companies  can charge  their  domestic  and small  business
customers over the first two years  following the  introduction  of competition,
taking into account its view of future electricity purchase costs. For SEEBOARD,
this proposal  reduces prices in real terms by 6% for the regulatory year ending
March 31, 1999 and a further 3% for the following  regulatory  year ending March
31, 2000.

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<PAGE>

      Other
      Reference is made to NOTE 2.  LITIGATION  AND REGULATORY  PROCEEDINGS  for
information regarding fuel proceedings at CPL, SWEPCO and WTU.


 PROPOSED AEP MERGER

      On December 22, 1997, CSW and AEP announced that their boards of directors
had  approved a  definitive  merger  agreement  for a tax-free,  stock-for-stock
transaction   creating  a  company  with  a  total  market   capitalization   of
approximately $28.1 billion ($16.5 billion in equity;  $11.6 billion in debt and
preferred  stock).  CSW expects the combination to be accounted for as a pooling
of interests.  The transaction must satisfy many  conditions,  some of which may
not be waived by the parties. There can be no assurance that the AEP Merger will
be consummated.

      This  combination  is  expected to create one of the  nation's  preeminent
diversified  electric  utilities  serving more than 4.6 million  customers in 11
states and  approximately 4 million  customers  outside the United States.  Both
companies  have  low-cost  generation  and offer their  customers in every state
prices below the  national  average.  Over the last two years,  both CSW and AEP
have ranked among the top five electric  utilities in customer  satisfaction  in
the ACSI.

      Under the merger  agreement,  each common  share of CSW will be  converted
into 0.6 shares of AEP common stock.  Based upon AEP's closing price immediately
prior to the merger announcement, this represented a premium of 20% over the CSW
closing  price.  AEP  will  issue  approximately  $6.6  billion  in stock to CSW
stockholders   to  complete  the   transaction.   CSW   stockholders   will  own
approximately 40% of the combined company.  Both companies anticipate continuing
their current dividend policies until the close of the transaction.

      Under the merger agreement, there will be no changes required with respect
to the  public  debt  issues,  the  outstanding  preferred  stock  or the  Trust
Preferred Securities of CSW or its subsidiaries.

      The   companies   anticipate   net  savings   related  to  the  merger  of
approximately  $2  billion  over  a  10-year  period  from  the  elimination  of
duplication in corporate and administrative  programs,  greater  efficiencies in
operations and business processes,  increased purchasing  efficiencies,  and the
combination of the two workforces. At the same time, the companies will continue
their commitment to high quality,  reliable service.  Job reductions  related to
the  merger  are  expected  to be  approximately  1,050 out of a total  domestic
workforce of approximately  25,000.  The combined company will use a combination
of growth,  reduced  hiring and  attrition  to  minimize  the need for  employee
separations.  Organizational  and  staffing  recommendations  will  be  made  by
transition teams of employees from both companies.

      The  electric  systems of AEP and CSW will  operate on an  integrated  and
coordinated  basis as required  by the Holding  Company  Act.  Any fuel  savings
resulting from the coordinated  operation of the combined company will be passed
on to customers.

      The merger agreement  contains  covenants and agreements that restrict the
manner in which the parties may operate their  respective  businesses  until the
time of closing of the merger. In particular,  without the prior written consent
of AEP,  CSW may not  engage in a number of  activities  that  could  affect its
sources  and  uses of  funds.  Pending  closing  of the  merger,  CSW's  and its
subsidiaries'  strategic investment activity,  capital expenditures and non-fuel
operating and  maintenance  expenditures  are restricted to specific agreed upon
projects or agreed upon  amounts.  In  addition,  prior to  consummation  of the
merger CSW and its subsidiaries are restricted from (i) issuing shares of common
stock other than  pursuant to employee  benefit  plans,  (ii) issuing  shares of
preferred  stock  or  similar   securities  other  than  to  refinance  existing
obligations or to fund permitted  investment or capital  expenditures  and (iii)
incurring indebtedness other than pursuant to existing credit facilities, in the
ordinary   course  of  business  or  to  fund  permitted   projects  or  capital
expenditures.  These  restrictions  are not expected to limit the ability of CSW

                                       17
<PAGE>

and its subsidiaries to make investments and expenditures in amounts  previously
budgeted.

      The merger is  conditioned,  among other things,  upon the approval of CSW
stockholders and several state and federal regulatory agencies. AEP shareholders
must authorize  additional  common stock and approve a new common stock issuance
to be used in the exchange for CSW common stock.  The companies  anticipate that
regulatory  approvals  can be  obtained  in 12 to 18  months  from  the  date of
announcement. See NOTE 16. PROPOSED AEP MERGER.



                                       18
<PAGE>


OTHER MERGER AND ACQUISITION ACTIVITIES

      Settlement of Litigation  Related to Termination of El Paso Merger In July
      1997, CSW and El Paso reached a settlement agreement that resolved
all of the pending  litigation  resulting  from the  termination of the proposed
merger. Under the terms of the settlement  agreement,  CSW and El Paso agreed to
dismiss all pending  claims in the litigation and give a mutual release from any
potential  claims  related  to the  El  Paso  Merger  Agreement  or the  pending
litigation,  and CSW paid $35 million to El Paso, various of its creditor groups
under its plan of  reorganization,  and its attorneys.  CSW recorded a charge of
$25 million in the first quarter of 1997 following the court's interim order and
recorded an  additional  charge of $10 million in the second  quarter of 1997 to
fully recognize the $35 million  settlement amount. The bankruptcy court vacated
the interim order and approved the settlement agreement.  See NOTE 2. LITIGATION
AND REGULATORY PROCEEDINGS.

      SWEPCO Cajun Asset Purchase Proposal
      On March 18, 1998,  SWEPCO,  together  with the Cajun  Members  Committee,
which  currently   represents  7  of  the  12  Louisiana   member   distribution
cooperatives  that are served by Cajun,  filed the SWEPCO Plan in the bankruptcy
court. Under the SWEPCO Plan, a SWEPCO affiliate or subsidiary would acquire all
of the  non-nuclear  assets  of Cajun,  comprised  of the  two-unit  Big Cajun I
natural  gas-fired  plant,  the  three-unit Big Cajun II coal-fired  plant,  and
related  non-nuclear  assets,  for $940.5 million in cash, subject to adjustment
pursuant to terms of the asset purchase agreement proposed as part of the SWEPCO
Plan. The SWEPCO Plan  incorporates  the terms of a settlement  between the RUS,
the Cajun Members Committee, Claiborne Electric Cooperative, Inc. and SWEPCO.

      The SWEPCO Plan filed March 18, 1998  replaces  plans filed  previously by
SWEPCO on January 15, 1998,  October 26, 1996,  September 30, 1996 and April 19,
1996. Two competing plans of reorganization  for the non-nuclear assets of Cajun
have been filed with the bankruptcy court, each with different  purchase prices,
rate paths and other  provisions.  Confirmation  hearings in Cajun's  bankruptcy
case are now scheduled  through April 1998.  Consummation  of the SWEPCO Plan is
conditioned upon confirmation by the bankruptcy court, and the receipt by SWEPCO
and CSW of all requisite state and federal  regulatory  approvals in addition to
their board  approvals.  If the SWEPCO  Plan is  confirmed,  the $940.5  million
required to consummate the acquisition of Cajun's non-nuclear assets is expected
to be financed  through a  combination  of external  borrowings  and  internally
generated funds with  approximately  70% of the external  borrowings funded with
non-recourse  debt.  There  can be no  assurance  that the  SWEPCO  Plan will be
confirmed  by the  bankruptcy  court  or,  if it is  confirmed,  that it will be
approved by federal and state regulators.  For additional  information regarding
the SWEPCO Cajun asset purchase  proposal see NOTE 3. COMMITMENTS AND CONTINGENT
LIABILITIES.


OTHER INITIATIVES

      As described in OVERVIEW,  a vital part of CSW's future strategy  involves
initiatives  that are outside of the traditional  United States electric utility
industry due to increasing competition and fundamental changes in this industry.
In addition, lower anticipated growth rates in CSW's core United States electric
utility business combined with the aforementioned industry factors have resulted
in CSW pursuing other  initiatives.  These  initiatives  have taken a variety of
forms; however, they are all consistent with the overall plan for CSW to develop
a global energy business. CSW has restrictions on the amounts it may spend under
the AEP merger agreement. While CSW believes that such initiatives are necessary
to maintain its  competitiveness and to supplement its growth in the future, the
Holding Company Act may impede or delay its ability to successfully  pursue such
initiatives  (The foregoing  statement  constitutes a forward looking  statement
within the meaning of Section 21E of the Exchange Act. Actual results may differ
materially  from such  projected  information  due to changes in the  underlying
assumptions.  See FORWARD  LOOKING  INFORMATION).  See RECENT  DEVELOPMENTS  AND
TRENDS.

                                       19
<PAGE>


      CSW Energy and CSW International
      CSW Energy  presently  owns  interests  in six  operating  power  projects
totaling 978 MW which are located in Colorado, Florida and Texas. In addition to
these projects,  CSW Energy has other projects in various stages of development.
In August 1997,  an affiliate of CSW Energy sold 50% of its 100% interest in the
Sweeny Cogeneration  project. CSW Energy provided the $56.5 million non-recourse
financing for the sale which is expected to be repaid from project distributions
or proceeds from sale, as defined in the sales  agreements.  Construction of the
330 MW  electricity  generating  facility  was  completed  in early  1998 with a
commercial  operation  date of February 1, 1998.  CSW Energy did not recognize a
gain or loss on this transaction.

      CSW International was organized to pursue investment opportunities in EWGs
and FUCOs. CSW International  currently holds investments in the United Kingdom,
Mexico and Latin  America.  CSW  International  acquired a minority  interest in
Vale,  a  Brazilian  electric  utility  company,  for an initial  investment  of
approximately  $40 million in December  1996. In 1997,  CSW  International  made
additional  equity  investments of approximately  $150 million in Latin America.
The $190 million used to make the equity investments was funded through loans to
CSW  International  by CSW Energy.  CSW Energy  obtained the funds from its $200
million  Senior Note issuance in October 1996.  CSW  International  continues to
seek to expand into other countries in Latin America, Europe, and Asia that meet
its investment  criteria and the investment criteria contained in the AEP merger
agreement.

      C3 Communications
      C3  Communications  has two active business units; its Utility  Automation
Division and a telecommunications partnership, ChoiceCom.

      C3  Communications'   Utility  Automation  Division  performs  consulting,
implementation and integration of utility meter automation products and services
for traditional  utility  companies and, as competition  markets open, in states
like California,  for energy service providers. C3 Communications offers clients
innovative  meter-based  competitive  data services  including  automated  meter
reading;  hourly,  daily and monthly delivery of consumption data; advanced load
profiling  data;  aggregation  reports for customers with multiple  accounts and
operational services like outage and tamper detection and  real-time-pricing and
time-of use data.

      ChoiceCom  offers  telecommunications  services  including local telephone
service, long distance and long-haul data transmission services. ChoiceCom began
offering local telephone service in August, 1997, in Austin,  Corpus Christi and
San Antonio,  Texas with an emphasis on the business  customer.  ChoiceCom  also
installed  state-of-the-art  Lucent 5ESS(R)  switches in those three cities.  In
January 1998,  ChoiceCom began offering  telephone service in Dallas and Houston
with plans to install Lucent  5ESS(R)  switches in both cities by the end of the
year.  With the  addition of Dallas and  Houston,  ChoiceCom's  expected  5-year
capital budget has increased to $210 million from $104 million.  The partnership
has grown to about 150 employees during its first year of operation.

      In November 1997, the parties  amended the ChoiceCom  Limited  Partnership
Agreement to provide  that CSW hold 100% of the  economic  interest in ChoiceCom
and 60% of the voting interest. ICG Communications, Inc. holds the remaining 40%
voting  interest  in  ChoiceCom,  and has an  option to  acquire a 50%  economic
interest in  ChoiceCom.  In the event that its option  terminates  without being
exercised, ICG Communications,  Inc. will be bound by a non-compete agreement in
CSW's service territory.

      EnerShop
      EnerShop  currently  provides  energy services to customers in Texas which
help reduce customers' operating costs through increased energy efficiencies and
improved  equipment  operations.  EnerShop  utilizes  the skills of local  trade
allies in offering services that include energy and facility  analysis;  project
management;  engineering  design,  equipment  procurement and construction;  and
performance monitoring.

                                       20
<PAGE>

      Other Ventures
      CSW Energy Services will spearhead CSW's competitive efforts in the retail
electricity  markets of states outside of CSW's historical service  territories.
CSW Energy  Services  will seek to secure  electricity  supply  business  in the
markets which soon will have retail  competition,  and will enable CSW to extend
its business reach and name recognition beyond CSW's traditional  customer base.
In March 1998,  CSW Energy  Services  signed its first major supply  contract in
California.  The CSW Services  Business  Ventures group pursues energy  projects
related to the business  activities of the U.S.  Electric  Operating  Companies.
Projects for these groups include staffing services for electric utility nuclear
power plants, energy management systems, electric substation automation software
and electric vehicles.  In June 1997, the FERC approved the request of CSW Power
Marketing  to sell  power and  energy  at  market-based  rates in the  wholesale
market. CSW has temporarily suspended this initiative in light of the AEP Merger
since AEP is already pursuing this initiative.


SOUTH TEXAS PROJECT

      CPL owns 25.2% of STP, a two-unit  nuclear  power  plant  which is located
near Bay City,  Texas.  HL&P owns 30.8%, San Antonio owns 28.0%, and Austin owns
16.0% of STP.  STP Unit 1 was placed in service in August  1988,  and STP Unit 2
was placed in service in June 1989.

      STP Unit 1 and Unit 2 were removed from service  during 1997 for scheduled
refueling outages which lasted 24 days and 18 days,  respectively.  For the year
1997,  Unit 1 and Unit 2 operated  at net  capacity  factors of 90.1% and 91.0%,
respectively.

      In  September  1997,  STPNOC was formed to replace HL&P as the STP Project
Manager.  Each of the four STP co-owners are  represented on the STPNOC board of
directors.  The CPL  representative  has been elected as the initial chairman of
the board of directors.  On October 1, 1997, all HL&P employees  assigned to STP
were transferred from HL&P to STPNOC.  On November 17, 1997, HL&P was removed as
STP Project  Manager,  and STPNOC became the operator of the plant. CSW believes
the formation of STPNOC is in its best interest.

      The establishment of STPNOC provides the following advantages:  (i) allows
the  management and work force to focus  exclusively  on the safe,  reliable and
efficient  operation of the STP units;  (ii) removes most of the  possibility of
disputes  between the four  owners over the  operation  of the  facility;  (iii)
removes dissension  concerning the potential liability of HL&P who was acting as
the project manager;  and (iv) allows the management of the facility to tailor a
total  compensation  package  for the STP work force  which best suits that work
force and its needs.  In  addition,  the  formation  and  operation of STPNOC is
expected  to result in a  decrease  in costs  allocable  to CPL  related  to its
investment  in STP  (The  foregoing  statement  constitutes  a  forward  looking
statement  within the meaning of Section 21E of the Exchange Act. Actual results
may differ  materially  from such  projected  information  due to changes in the
underlying assumptions. See FORWARD LOOKING INFORMATION).

      For additional information regarding STP and the accounting for the
decommissioning of STP, see NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
and NOTE 2. LITIGATION AND REGULATORY PROCEEDINGS.


ENVIRONMENTAL MATTERS

      The  operations of the CSW System,  like those of other  utility  systems,
generally  involve the use and disposal of substances  subject to  environmental
laws.  CERCLA,  the  federal  "Superfund"  law,  addresses  the cleanup of sites
contaminated by hazardous substances. Superfund requires that PRPs fund remedial

                                       21
<PAGE>

actions  regardless of fault or the legality of past disposal  activities.  PRPs
include  owners and  operators of  contaminated  sites and  transporters  and/or
generators of hazardous substances.  Many states have similar laws. Legally, any
one PRP can be held  responsible  for the  entire  cost of a  cleanup.  Usually,
however, cleanup costs are allocated among PRPs.

      The U.S.  Electric  Operating  Companies  are  subject to various  pending
claims  alleging  that they are PRPs under  federal or state  remedial  laws for
investigating  and  cleaning  up  contaminated   property.   CSW  believes  that
resolution of these claims,  individually  or in the aggregate,  will not have a
material  adverse effect on CSW's results of operations or financial  condition.
Although the reasons for this expectation differ from site to site, factors that
are the basis for the  expectation  for specific sites include the volume and/or
type of waste allegedly  contributed by the U.S. Electric Operating Company, the
estimated amount of costs allocated to the U.S.  Electric  Operating Company and
the participation of other parties (The foregoing statements  constitute forward
looking statements within the meaning of Section 21E of the Exchange Act. Actual
results may differ materially from such projected  information due to changes in
the  underlying  assumptions.  See  FORWARD  LOOKING  INFORMATION).  See NOTE 2.
LITIGATION AND REGULATORY  PROCEEDINGS  and NOTE 3.  COMMITMENTS  AND CONTINGENT
LIABILITIES for additional discussion regarding environmental matters.

      The EPA recently promulgated  revised,  more stringent ambient air quality
standards  for ozone and  particulates.  While  these  standards  do not mandate
emission levels for facilities such as electricity generating power plants, they
may  result in more  areas  being  designated  as  non-attainment  for these two
pollutants.  States will be required to develop strategies to achieve compliance
in  these  areas,   strategies  that  may  include  lower  emission  levels  for
electricity  generating power plants,  possibly including  facilities within the
CSW System. The impact, if any, on CSW or the U.S. Electric Operating  Companies
cannot yet be determined, but the impact could be significant.

      At the Kyoto  Conference  on Global  Warming held in December  1997,  U.S.
representatives  agreed to a treaty  which  could  require  new  limitations  on
"greenhouse  gases"  from  power  plants.  CSW and the U.S.  Electric  Operating
companies  could be affected  if this  treaty is  approved by the United  States
Congress in its present form.  The impact,  if any, on CSW or the U.S.  Electric
Operating  Companies  cannot  yet  be  determined,   but  the  impact  could  be
significant.


RISK MANAGEMENT

      In  October  1997,  CSW's  board of  directors  adopted a risk  management
resolution authorizing CSW to engage in currency,  interest rate and energy spot
and forward  transactions and related  derivative  transactions on behalf of CSW
with foreign and domestic parties as deemed appropriate by executive officers of
CSW. The risk  management  program is  necessary to meet the growing  demands of
CSW's customers for  competitive  prices and price  stability,  to enable CSW to
compete in a deregulated  power  industry,  to manage the risks  associated with
domestic and foreign  investments and to take advantage of strategic  investment
opportunities.

      The U.S. Electric Operating Companies experience commodity price exposures
related to the purchase of fuel supplies for the generation of  electricity  and
for the purchase of power and energy from other  generation  sources.  Contracts
that  provide for the future  delivery of these  commodities  can be  considered
forward  contracts  which  contain  pricing  and/or  volume  terms  designed  to
stabilize the cost of the commodity.  Consequently,  the U.S. Electric Operating
Companies  manage their price exposure for the benefit of customers by balancing
their  commodity  purchases  through a combination  of long-term and  short-term
(spot-market) agreements.  In addition,  SEEBOARD has entered into contracts for
differences  to reduce  exposure  to  fluctuations  in the price of  electricity
purchased  from the  United  Kingdom's  electricity  power  pool.  This pool was
established at privatization of the United Kingdom's  electric  industry for the

                                       22
<PAGE>

bulk trading of electricity  between  generators and suppliers.  At December 31,
1997,  the gross value of such  contracts for  differences  amounted to not more
than 80% of any year's expected power purchases.

      CSW has, at times,  been exposed to currency and interest rate risks which
reflect the floating  exchange rate that exists between the U.S.  dollar and the
British pound since its purchase of SEEBOARD in 1995.  CSW has utilized  certain
risk  management  tools to  manage  adverse  changes  in  exchange  rates and to
facilitate financing  transactions resulting from CSW's acquisition of SEEBOARD.
At the end of 1997, CSW had positions in two cross currency swap contracts.  The
following table presents  information  relating to these  contracts.  The market
value represents the foreign  exchange/interest rate terms inherent in the cross
currency swaps at current market pricing. CSW expects to hold these contracts to
maturity.  At current  exchange  rates,  this liability is included in long-term
debt on the balance sheet at a carrying value of approximately $425 million.

                           Expected            Expected
                         Cash Inflows        Cash Outflows
  Contract               Maturity Date      (Maturity Value)    (Market Value)
  -----------------------------------------------------------------------------
  Cross currency swap    August 1, 2001       $200 million      $216.5 million
  Cross currency swap    August 1, 2006       $200 million      $226.8  million
                        

OTHER MATTERS

      Year 2000
      In 1996,  a  system-wide  program to prepare  CSW's  computer  systems and
applications  for the year 2000 was  initiated.  CSW  expects to incur  internal
staff costs as well as consulting and other expenses  related to  infrastructure
and facilities  enhancements necessary to prepare the systems for the year 2000.
Testing and  conversion  is expected to cost between $20 million and $21 million
over the next two years  including  both  domestic  and  foreign  operations.  A
significant  portion  of  these  costs  is  likely  to be  covered  through  the
redeployment  of  existing  resources.  The major  applications  which  pose the
greatest risk for CSW if  implementation  is not successful are the transmission
and  distribution  automation  system;  the  time in use,  demand  and  recorder
metering system for commercial and industrial  customers;  and the power billing
system.  The potential  problems  related to these systems are electric  service
interruptions to customers, interrupted revenue data gathering and poor customer
relations  resulting from delayed  billing,  respectively.  Costs related to the
year 2000 program will be expensed as incurred.

      Adoption of Rights Plan
      In September 1997, CSW's board of directors adopted a Rights Plan, subject
to SEC  approval  under the Holding  Company  Act.  SEC approval was received in
December  1997, and on December 22, 1997, CSW executed the Rights Plan which had
been modified to permit the AEP Merger.  The Rights Plan was  initially  adopted
and ultimately  executed as part of the fiduciary  responsibility of CSW's board
of directors and was not adopted  because of any takeover  offer or threat.  The
intent of the Rights Plan is to assure fair and equal treatment for all of CSW's
stockholders  in the event of a hostile  takeover  attempt  and to  encourage  a
potential  acquirer to negotiate with CSW's board of directors before attempting
a takeover to assure a fair price for all stockholders.

      On January 6, 1998, CSW made a dividend distribution of one right for each
outstanding share of its common stock. Each right initially  entitles the holder
to buy  one-tenth  of one share of CSW  Common  for $50.  Prior to the date upon
which the rights become  exercisable  under the Rights Plan,  CSW's  outstanding
stock  certificates  will  represent  both the  shares of  common  stock and the
rights, and the rights will trade only together with the shares.

                                       23
<PAGE>

      Under the Rights Plan, a  "triggering  event" would occur ten days after a
person or group  acquires or  announces  a tender or  exchange  offer to acquire
fifteen  percent  or  more  of  CSW's  outstanding  common  stock.  Upon  such a
"triggering  event," the rights would become exercisable and trade independently
of CSW's common stock.  After a person or group acquires fifteen percent or more
of CSW's  outstanding  common  stock,  each  right  (except  those  held by such
acquiring person or group, whose rights would become void),  entitles the holder
to purchase,  at the exercise  price,  CSW common shares having a current market
value of two times the exercise  price. If CSW was acquired in a merger or other
business  combination,  each right would entitle the holder to purchase,  at the
exercise  price,  common stock of the acquirer  having a current market value of
two times the exercise  price. In either case,  after a triggering  event occurs
but before an acquiring  person  becomes the owner of at least fifty  percent of
CSW's outstanding common stock, CSW's board of directors may direct the exchange
of one share of CSW's  common  stock for each  right  then  outstanding  and not
exercised.  The  Rights  Plan  exempts  the AEP Merger  transaction.  Therefore,
neither the execution of the AEP merger  agreement nor  consummation  of the AEP
Merger  caused,  or will  cause a  "triggering  event"  or the  rights to become
exercisable.  See PROPOSED AEP MERGER for additional information on the proposed
merger.

      CSW's board of directors may redeem the rights for a price of one cent per
right prior to the earlier of the rights becoming  exercisable or the expiration
of the Rights  Plan.  The rights will expire ten years from the  effective  date
unless they are earlier redeemed or exchanged by CSW.


NEW ACCOUNTING STANDARDS

      SFAS No. 125
      SFAS No. 125 provides accounting and reporting standards for transfers and
servicing  of  financial  assets  and  extinguishment  of  liabilities  using  a
financial-components  approach  that  focuses on control.  An entity  recognizes
assets it controls and derecognizes assets when control has been surrendered and
liabilities  when they have been  extinguished.  A  transfer  of assets in which
control of the asset is surrendered  is recorded as a sale.  Control of an asset
is  surrendered  only  when  and if  certain  conditions  are met.  Likewise,  a
liability is only extinguished  under certain distinct  conditions.  CSW adopted
SFAS No. 125 effective January 1, 1997.  Adoption of this standard has not had a
material adverse effect on CSW's results of operations or financial condition.

      SFAS No. 128
      On March 3, 1997, the FASB issued SFAS No. 128, effective for financial
statements for periods ending after December 15, 1997.  SFAS No. 128 will
simplify the computation of earnings per share for many companies by eliminating
calculation provisions which were required by the prior earnings per share
standard, Accounting Principles Board Opinion No. 15.  CSW adopted SFAS No. 128
effective December 31, 1997.  Adoption of SFAS No. 128 did not have a material
effect on its calculation of earnings per share.

      SFAS No. 130
      This statement is effective for fiscal years  beginning after December 15,
1997. The statement adds the requirement to present comprehensive income and all
of its  components  (revenues,  expenses,  gains  and  losses)  in a full set of
financial  statements,  and this new statement  must be displayed  with the same
prominence given other financial statements.  Comprehensive income is defined as
the change in equity (net assets) of a business  enterprise during a period from
transactions  and other events and  circumstances  from  non-owner  sources.  It
includes  all changes in equity  during a period  except  those  resulting  from
investments  by owners and  distributions  to owners.  Though  effective  at the
beginning  of 1998,  comprehensive  income is not  required to be  disclosed  in
interim statements in the year adopted.  CSW will adopt this statement beginning
with 1998 year-end financial statements.

                                       24
<PAGE>

      SFAS No. 131
      This statement is effective for fiscal years  beginning after December 15,
1997,  and  requires  that  certain  information  about  operating  segments  be
presented  in  complete  sets of  financial  statements.  It also  requires  the
presentation of information regarding products and services, geographic areas in
which the entity operates, and concentrations of major customers.

      The  objective  of this  statement  is to  provide  information  about the
different  types of  business  activities  in which an  entity  engages  and the
different economic  environments in which it operates to help users of financial
statements  better  understand an entity's  performance and prospects for future
cash flows and make more informed judgments about the enterprise as a whole.

      An operating  segment is a component of an enterprise  that earns revenues
and incurs expenses,  whose results are regularly reviewed by the chief decision
maker,  and for which  discrete  financial  information  is available.  Separate
information  is required to be  presented  for any segment that is 10 percent or
more of reported income,  profit or loss, or assets of the combined entity.  CSW
will adopt this statement beginning with 1998 year-end financial statements.



RESULTS OF OPERATIONS

COMPARISON OF THE YEARS ENDED DECEMBER 31, 1997 AND 1996

      CSW's  earnings  decreased  to $153  million in 1997 from $429  million in
1996.  CSW's return on average  common stock equity was 4.2% in 1997 compared to
12.1% in 1996.  The primary  reason for the lower earnings and return on average
common  stock  equity was the accrual of the one-time  United  Kingdom  windfall
profits tax. The impact of CSW's final  settlement  of  litigation  with El Paso
contributed  to the  decline  in  earnings  as well.  Also  contributing  to the
decrease  in  earnings  was the  effect  of both  the PSO 1997  Rate  Settlement
Agreement and the CPL 1997 Final Order.  See NOTE 2.  LITIGATION  AND REGULATORY
PROCEEDINGS for additional  information on CSW's final  settlement of litigation
with El  Paso,  the CPL  1997  Final  Order  and the PSO  1997  Rate  Settlement
Agreement.  See NOTE 17.  EXTRAORDINARY  ITEM for additional  information on the
windfall  profits tax.  Further  reducing  earnings for 1997 were certain  asset
write-offs  predominately at the U.S. Electric  Operating  Companies.  Partially
offsetting the lower earnings was the gain on the  reacquisition of a portion of
the U.S.  Electric  Operating  Companies'  preferred  stock and an adjustment to
deferred tax balances of $15 million resulting from a 2% reduction in the United
Kingdom  corporation tax rate. Further offsetting the decline in earnings was an
increase  in  non-fuel  electric  revenues.  Significant  items  impacting  1997
earnings are listed below (in millions).

                                                       Earnings
                                                        Impact
                                                      ---------

          United Kingdom Windfall Profits Tax           $(176)
          CPL 1997 Final Order                            (48)
          Asset Write-offs and Reserves                   (48)
          PSO 1997 Rate Settlement Agreement              (27)
          Settlement of Litigation with El Paso           (23)
          Gain on the Reacquisition of Preferred Stock     10
          United Kingdom Deferred Tax Adjustment           15

      In addition, several items that occurred in 1996 were not present in 1997.
Prior to the sale of Transok in 1996,  CSW realized $12 million of earnings from
Transok's  operations.  As a result of the sale,  CSW also recorded an after-tax
gain of approximately $120 million in 1996. However, the U.S. Electric Operating
Companies and CSW Energy recorded charges totaling $102 million,  after-tax, for
certain investments in the second quarter of 1996 which decreased earnings.  See

                                       25
<PAGE>

NOTE 14.  DISCONTINUED  OPERATIONS  for  additional  information  concerning the
effects of the sale of Transok.

      Operating  revenues  increased  $113 million in 1997 compared to 1996. The
revenue variances are shown in the following table.

                             1997 REVENUE VARIANCES
                      Increase (decrease) from prior year,
                                    millions

                    U.S. Electric
                     CPL and WTU Transmission Revenues    $56
                     KWH Sales, Growth and Usage           41
                     Fuel Revenue                          23
                     CPL 1996 Fuel Agreement               18
                     Sales for Resale                      12
                     CPL 1997 Final Order                 (45)
                     KWH Sales,  Weather-Related          (37)
                     PSO 1997 Rate Settlement Agreement   (32)
                     Other Electric                        37
                                                        --------
                                                           73
                    United Kingdom                         22
                    Other Diversified                      18
                                                        --------
                                                         $113
                                                        --------

      U.S. Electric revenues  increased $73 million,  or 2%, in 1997 compared to
1996.  Retail MWH sales  increased 2.5% with increases in all customer  classes.
U.S.  Electric  revenues  increased  primarily due to higher MWH sales resulting
from increased  customer usage and new  transmission  access revenues at CPL and
WTU in  accordance  with FERC  Order No.  888 and the  Texas  Commission's  rule
regarding  transmission access and pricing. The new transmission revenues had no
material  effect on earnings  because  they were almost  completely  offset by a
corresponding amount of transmission expense.  Revenues increased due in part to
the  absence  in 1997 of the  revenue  decrease  in 1996  from the CPL 1996 Fuel
Agreement.  An increase in fuel  revenues,  as discussed in fuel expense  below,
also  contributed  to the higher  revenues.  Partially  offsetting  the  revenue
increase was a decrease in  weather-related  demand due to milder weather in the
first nine months of 1997.  Further  offsetting  the  increase in U.S.  Electric
revenues was the revenue decrease from both the CPL 1997 Final Order and the PSO
1997  Rate  Settlement   Agreement.   See  NOTE  2.  LITIGATION  AND  REGULATORY
PROCEEDINGS  for additional  information on the CPL 1997 Final Order and the PSO
1997 Rate Settlement  Agreement.  United Kingdom revenues increased $22 million,
or 1%, in 1997 compared to 1996 due primarily to the effect of the exchange rate
movement  between the British pound and the U.S.  dollar,  partially offset by a
reduction  in the fossil fuel levy  collected  on behalf of the United  Kingdom.
Other diversified  revenues  increased $18 million,  or 31%, in 1997 compared to
1996  due   primarily  to  increased   revenues  from  CSW   International,   C3
Communications, CSW Credit and EnerShop.

      During 1997 and 1996 the U.S. Electric Operating  Companies  generated 93%
of their electric energy requirements.  U.S. Electric fuel expense increased $26
million to $1.3 billion in 1997 compared to 1996 due primarily to an increase in
natural  gas  fuel  costs  to  $2.67  per  MMbtu  from  $2.50  per  MMbtu.  Also
contributing to the increase was the absence in 1997 of a one-time  reduction to
fuel expense of  approximately  $9 million recorded in the first quarter of 1996
related to the CPL 1996 Fuel Agreement.  Partially offsetting these increases in
fuel expense was the effect of  lower-cost  coal.  United  Kingdom cost of sales
decreased approximately $40 million to $1.3 billion in 1997 compared to 1996 due
primarily  to a  reduction  in the fossil fuel levy  collected  on behalf of the
United  Kingdom  government,  which was  partially  offset by the  effect of the
exchange rate movement between the British pound and the U.S. dollar.

      Other  operating  expense  increased  $196 million to $981 million in 1997
compared  to 1996 due in part to the  absence in 1997 of a $27  million  pension
adjustment  recorded in the second quarter of 1996 at SEEBOARD  which  decreased

                                       26
<PAGE>

pension  expense.  The effect of the exchange rate movement  between the British
pound and U.S.  dollar  also  contributed  to the  increase  in other  operating
expense  of  SEEBOARD  U.S.A.  In  addition,  approximately  $56  million in new
transmission  access expense was recorded at CPL and WTU in 1997 related to FERC
Order No. 888 and the Texas Commission rules regarding  transmission  access and
pricing.  Also  increasing  other  operating  expense were asset  write-offs  of
approximately  $57 million  including  certain  regulatory  assets,  capitalized
demand  side  management  assets and  obsolete  inventories.  In  addition,  the
settlement of litigation  with El Paso  increased  other  operating  expense $35
million. Further contributing to the increase in other operating expense was the
$12 million  impact of the CPL 1997 Final Order and the $4 million impact of the
PSO 1997  Rate  Settlement  Agreement.  See NOTE 2.  LITIGATION  AND  REGULATORY
PROCEEDINGS  for additional  information on the CPL 1997 Final Order and the PSO
1997 Rate Settlement  Agreement.  Partially  offsetting these increases were the
absence in 1997 of expenses recorded in 1996 related to inventory  write-offs of
$10 million and CPL rate case adjustments of $15 million. Further offsetting the
increases  were  charges  in 1996  associated  with  restructuring  costs.  Also
partially offsetting the increase in other operating expense was reduced pension
expense  in 1997  resulting  from  changes  made to the  pension  plan for CSW's
domestic employees. See NOTE 5. BENEFIT PLANS for additional information related
to the changes in the pension plan.

      Depreciation and  amortization  expense  increased $33 million,  or 7%, in
1997 due primarily to the  implementation  of depreciation  and  amortization in
accordance  with the CPL  1997  Final  Order.  As a result  of that  order,  the
increase in depreciation  due to the  accelerated  recovery of ECOM property was
offset in part by the  implementation of lower  depreciation  rates. Taxes other
than  income  increased  $17  million,  or 10%,  in 1997  compared  to 1996  due
primarily to higher property taxes at CPL and the absence in 1997 of a CPL Texas
franchise  tax refund and  true-up in 1996.  Income tax  expense  decreased  $73
million to $151 million in 1997 due primarily to lower pre-tax  income and a $15
million adjustment to deferred income tax balances resulting from a 2% reduction
in the United Kingdom corporation tax rate.

        Other income and  deductions  increased to a gain of $32 million in 1997
from a loss of $61  million  in 1996 due  primarily  to the  absence  in 1997 of
charges  for  certain  investments  recorded  in the  second  quarter of 1996 of
approximately $84 million,  after tax, at the U.S. Electric Operating  Companies
and $18 million at CSW Energy.  Long-term interest expense increased $8 million,
or 2%, in 1997 due primarily to interest expense resulting from a fourth quarter
1996  debt  issuance  by CSW  Energy.  Short-term  and  other  interest  expense
decreased $8 million to $86 million in 1997 when  compared to 1996 due primarily
to lower levels of short-term  borrowings.  Distributions on newly-issued  Trust
Preferred  Securities  increased  interest  and other  charges by $17 million in
1997, which was partially offset by lower dividend  requirements  resulting from
the  related  preferred  stock  reacquisitions  at the U.S.  Electric  Operating
Companies. See NOTE 10. TRUST PREFERRED SECURITIES for additional information on
the new securities.


COMPARISON OF THE YEARS ENDED DECEMBER 31, 1996 AND 1995

      CSW's earnings  increased to $429 million in 1996 compared to $402 million
in 1995. Although earnings increased, earnings per share decreased from $2.10 in
1995 to $2.07 in 1996 due to the issuance of  additional  shares of common stock
during  1996.  The  return on  average  common  stock  equity  was 12.1% in 1996
compared to 13.1% in 1995. U.S. Electric  operations  contributed  approximately
57% of total earnings in 1996 and approximately  105% of total earnings in 1995.
The lower percent for U.S. Electric  operations is mostly attributed to the gain
on the sale of Transok,  higher earnings from SEEBOARD U.S.A.  and the recording
of  charges  at  each of the  U.S.  Electric  Operating  Companies  for  certain
investments.  SEEBOARD  U.S.A.  contributed  24% of  total  earnings  in 1996 as
compared to 2% in 1995,  reflecting a full year of earnings in 1996  compared to
only a partial quarter in 1995.

      Earnings increased in 1996 compared to 1995 due primarily to the gain from
the sale of Transok,  the additional  earnings from SEEBOARD U.S.A., the absence
of charges in 1996 related to the  termination of the proposed El Paso Merger in

                                       27
<PAGE>

June 1995 and the effect of the CPL 1995  Agreement.  Also  contributing  to the
increase were higher non-fuel electric revenues  resulting from increased usage,
customer growth and weather-related demand. Partially offsetting these increases
in  earnings  were the  recording  of  charges  by the U.S.  Electric  Operating
Companies  in June 1996  associated  with  certain  investments,  write-offs  of
certain equity  investments and other project  development costs for CSW Energy,
restructuring  charges,  the  effect of the CPL 1996 Fuel  Agreement,  the asset
reserves for the pending CPL rate case and the absence in 1996 of favorable  tax
adjustments  made  in  1995.  Additional  information  related  to the  reserves
recorded  in June 1996 is  discussed  below.  For  further  discussion  of CPL's
regulatory  activities,  see  NOTE 2.  LITIGATION  AND  REGULATORY  PROCEEDINGS.
Increased  depreciation  and  amortization,  increased other operating  expense,
increased interest expense and the loss of Mirror CWIP earnings also reduced the
increase in earnings. Significant items impacting 1996 earnings are listed below
(in millions).

                                                Earnings
                                                 Impact
                                                --------
               Gain on the Sale of Transok        $120
               Charges for Certain Investments    (104)
               CPL Pending Rate Case Write-offs     (8)
               CPL 1996 Fuel Agreement              (7)

      Revenues increased approximately $2.0 billion or 64% in 1996 when compared
to 1995. The revenue variances are shown in the following table.

                             1996 REVENUE VARIANCES
                      Increase (decrease) from prior year,
                                    millions

                    U.S. Electric
                     Fuel Revenues                       $181
                     CPL 1995 Agreement                   112
                     KWH Sales, Growth and Usage           83
                     KWH Sales, Weather-Related            21
                     WTU 1995 Stipulation and Agreement    21
                     Other Electric                       (35)
                     CPL 1996 Fuel Agreement              (18)
                                                       --------
                                                          365
                    United Kingdom                      1,640
                    Other Diversified                       7
                                                       --------
                                                        $2,012
                                                       --------

      U.S. Electric  revenues  increased $365 million or 13% in 1996 compared to
1995.  Total U.S.  Electric KWH sales  increased  4.2%,  with increases in sales
among  all  retail  customer  classes.  Customer  growth,  increased  usage  and
weather-related  demand  contributed to the increased revenues along with higher
fuel  revenues as discussed  below.  Also  contributing  to the increase was the
absence in 1996 of reserves for refunds  recorded in 1995 in accordance with the
CPL 1995  Agreement and the WTU 1995  Stipulation  and  Agreement.  KWH sales to
retail  customers  increased in 1996 as a result of customer  growth,  increased
customer usage and weather-related demand.

      CSW's operating  revenues also include  approximately  $1.8 billion from a
full year of revenues from SEEBOARD U.S.A.  for 1996 compared to $208 million of
revenues for a partial quarter of operations in 1995. Other diversified revenues
increased  13% to $59  million in 1996 as  compared  to $52  million in 1995 due
primarily to increased  revenues from CSW Energy projects,  increased  factoring
revenues at CSW Credit and new revenues from C3 Communications and EnerShop.

      During 1996 and 1995 the U.S. Electric Operating  Companies  generated 93%
and 95%, respectively, of their electric energy requirements. U.S. Electric fuel
expense increased 15% to approximately $1.1 billion in 1996 at the U.S. Electric

                                       28
<PAGE>

Operating  Companies  due  primarily  to an increase in the average unit cost of
fuel to $1.81 per MMbtu in 1996 from $1.58 per MMbtu in 1995,  reflecting higher
natural gas prices.  Partially  offsetting  this increase was a reduction in the
delivered cost of coal at the U.S. Electric Operating  Companies  resulting from
lower coal transportation costs and lower spot market coal prices. U.S. Electric
purchased  power  increased  $36 million to $77 million in 1996 due primarily to
increased  economy energy  purchases at a higher cost per MWH.  CSW's  operating
expenses  include  $1.3  billion  for cost of sales  from a full  year of United
Kingdom  operations in 1996 compared to $158 million  recorded in United Kingdom
cost of sales for a partial quarter of operations in 1995.

      Other operating expenses in 1996 increased $228 million, or 41%, from 1995
due primarily to the addition in 1996 of a full year of operating  expenses from
SEEBOARD  U.S.A.  as well as the  absence  in 1996 of reduced  expenses  in 1995
related to $28 million of regulatory assets established for previously  expensed
restructuring  charges and the  reversal of rate case costs  pursuant to the CPL
1995 Agreement. Also contributing to the increase was the recognition in 1995 of
a $13 million regulatory asset for previously recorded  restructuring charges in
accordance  with  the  WTU  1995  Stipulation  and  Agreement.   Another  factor
contributing to increased other operating expense was a CSW restructuring charge
recorded in 1996.  A $42 million  reserve for  deferred  merger and  acquisition
costs was  recorded  in 1995 from the  terminated  El Paso  merger.  Maintenance
expense  decreased  $5 million to $150 million in 1996 from $155 million in 1995
due primarily to a $10 million decrease in maintenance  expense at CPL resulting
from lower production and distribution  maintenance costs.  Partially offsetting
this  decrease  was a $7  million  increase  in  maintenance  expense  due  to a
write-down of  production  and  distribution  inventories  at the U.S.  Electric
Operating Companies in 1996.

      Depreciation and  amortization  increased 31% to $464 million in 1996 from
$353 million in 1995 due primarily to the addition of  depreciable  fixed assets
and the goodwill  amortization  related to the purchase of SEEBOARD,  as well as
increases in depreciable fixed assets at the U.S. Electric Operating  Companies.
Also contributing to the increase were the amortization of the regulatory assets
established  in 1995  associated  with the CPL 1995  Agreement  and the WTU 1995
Stipulation  and  Agreement  along with  accelerated  amortization  of  deferred
Oklaunion plant costs in accordance with the WTU 1995 Stipulation and Agreement.

      Taxes,  other than income  increased 10% to $178 million in 1996 from $162
million in 1995.  The increase was due  primarily to lower 1995 ad valorem taxes
resulting  from  revisions  of prior  year  estimates  recorded  in  1995.  Also
contributing to the increase were higher ad valorem and state franchise taxes at
SWEPCO in 1996.  The higher ad valorem taxes  resulted  primarily  from a higher
state assessed value in Louisiana and the addition of the HVdc tie in Texas. The
state  franchise  taxes  increased due mainly to higher  federal  taxable income
associated with Texas franchise tax. Income taxes increased $132 million to $224
million  during 1996  compared to 1995.  During  1995,  income  taxes were lower
primarily due to  adjustments  relating to prior year taxes,  as well as the tax
effect  from  both  the CPL 1995  Agreement  and the WTU  1995  Stipulation  and
Agreement.  Income taxes of $46 million were recorded for SEEBOARD U.S.A. from a
full year of operations in 1996 compared to $6 million for a partial  quarter of
operations in 1995.

                                       29
<PAGE>

      Other income and  deductions  decreased $160 million in 1996 when compared
to 1995 due primarily to charges  recorded in June 1996  associated with certain
investments for plant sites,  engineering  studies and lignite  reserves for the
U.S. Electric Operating Companies.  See the table below for additional detail on
these charges. Other income and deductions was also lower as a result of certain
write-offs  recorded by CSW Energy.  In addition,  CPL's Mirror CWIP  liability,
which has now been fully amortized, contributed $41 million to income in 1995.

                                  Pre-tax    
                                  effect on   Income tax   Net Income
                                  income       benefit      Effect
                                  -----------------------------------
                                          (thousands)

               CPL                $(21,509)    $5,940    $(15,569)
               PSO                (51,109)     15,401     (35,708)
               SWEPCO             (29,700)      7,885     (21,815)
               WTU                (14,949)      4,003    (10,946)
                                  -----------------------------------
                                  $(117,267)  $33,229   $(84,038)
                                  -----------------------------------

      Interest  on  long-term  debt  increased  $102  million or 46% during 1996
compared to 1995 due to higher levels of long-term debt  outstanding  related to
the  SEEBOARD  acquisition.  CSW's  1996  embedded  cost of  long-term  debt was
unchanged from 1995 at 7.2%. Interest on short-term debt decreased $7 million or
7% in 1996  compared  to 1995 due to lower  interest  rates and lower  levels of
short-term debt outstanding. CSW used a portion of the proceeds from the sale of
Transok to reduce short-term debt.

      The $120  million  gain on the sale of Transok as well as  Transok's  1996
operations are shown separately in discontinued  operations.  Transok's earnings
for the first five months of 1996 were $12 million  compared to $25 million from
a full year of operations for 1995. See NOTE 15. TRANSOK DISCONTINUED OPERATIONS
for information, including comparative statements of income, related to the sale
of Transok.

                                       30
<PAGE>
<PAGE>
CSW
CONSOLIDATED STATEMENTS OF INCOME
CENTRAL AND SOUTH WEST CORPORATION
------------------------------------------------------------------------
                                           For the Years Ended December 31,
                                            ----------------------------
                                              1997       1996      1995
                                            -------    -------    ------
                                        ($ in millions, except share amounts)
Operating Revenues
    U.S. Electric                            $3,321     $3,248    $2,883
    United Kingdom                            1,870      1,848       208
    Other diversified                            77         59        52
                                            -------    -------    ------
                                              5,268      5,155     3,143
                                            -------    -------    ------
Operating Expenses and Taxes
    U.S. Electric fuel                        1,177      1,151     1,004
    U.S. Electric purchased power                89         77        41
    United Kingdom cost of sales              1,291      1,331       158
    Other operating                             981        785       557
    Maintenance                                 152        150       155
    Depreciation and amortization               497        464       353
    Taxes, other than income                    195        178       162
    Income taxes                                151        224        92
                                            -------    -------    ------
                                              4,533      4,360     2,522
                                            -------    -------    ------
Operating Income                                735        795       621
                                            -------    -------    ------

Other Income and Deductions
    Mirror CWIP liability amortization         --         --          41
    U.S. Electric charges for investments
      and plant development costs                (3)      (117)     --
    Other                                        29         16        56
    Non-operating income taxes                    6         40         2
                                            -------    -------    ------
                                                 32        (61)       99
                                            -------    -------    ------
Income Before Interest and Other Charges        767        734       720
                                            -------    -------    ------

Interest and Other Charges
    Interest on long-term debt                  333        325       223
    Distributions on Trust Preferred
      Securities                                 17       --        --
    Interest on short-term debt and other        86         94       101
    Preferred dividend requirements
      of subsidiaries                            12         18        19
    Gain on reacquired preferred stock          (10)      --        --
                                            -------    -------    ------
                                                438        437       343
                                            -------    -------    ------

Income from Continuing Operations               329        297       377
                                            -------    -------    ------

Discontinued Operations
    Income from discontinued operations,
      net of tax of $6 for 1996 and $13
      for 1995                                 --           12        25
    Gain on the sale of discontinued
      operations, net of tax of $72            --          120      --
                                            -------    -------    ------
                                               --          132        25
                                            -------    -------    ------

Income Before Extraordinary Item                329        429       402

Extraordinary Item - United Kingdom
  windfall profits tax                         (176)      --        --
                                            -------    -------    ------

Net Income for Common Stock                    $153       $429      $402
                                            =======    =======    ======

Average Common Shares Outstanding             212.1      207.5     191.7

Basic and Diluted EPS from Continuing 
  Operations                                  $1.55      $1.43     $1.97
Basic and Diluted EPS from Discontinued 
  Operations                                    --        0.64      0.13
                                            -------    -------    ------
Basic and Diluted EPS before 
  Extraordinary Item                           1.55       2.07      2.10
Basic and Diluted EPS from 
  Extraordinary Item                          (0.83)       --        --
                                            -------    -------    ------
Basic and Diluted EPS                         $0.72      $2.07     $2.10
                                            =======    =======    ======

Dividends Paid per Share of Common Stock      $1.74      $1.74     $1.72
                                            =======    =======    ======

   The accompanying notes to consolidated financial statements are an integral
                           part of these statements.

                                       31
<PAGE>
CSW
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
CENTRAL AND SOUTH WEST CORPORATION
---------------------------------------------------------------------------
                                               For the Years Ended December 31,
                                                 --------------------------
                                                   1997      1996     1995
                                                 -------    ------   ------
                                                          (millions)

Common Stock at Beginning of Year                   $740      $675     $667
    Sale of Common Stock                               3        65        8
                                                 -------    ------   ------
Common Stock at End of Year                          743       740      675
                                                 -------    ------   ------

Paid-in Capital at Beginning of Year               1,022       610      561
    Sale of Common Stock                              17       412       49
                                                 -------    ------   ------
Paid-in Capital at End of Year                     1,039     1,022      610
                                                 -------    ------   ------

Retained Earnings at Beginning of Year             1,963     1,893    1,824
    Net income for common stock                      153       429      402
    Deduct:  Common stock dividends                  369       358      329
    Deduct:  Other                                     1         1        4
                                                 -------    ------   ------
Retained Earnings at End of Year                   1,746     1,963    1,893
                                                 -------    ------   ------

Foreign Currency Translation and Other
  at Beginning of Year                                77      --       --
    Net Change                                       (49)       77     --
                                                 -------    ------   ------
Foreign Currency Translation and Other
  at End of Year                                      28        77     --
                                                 -------    ------   ------


                                                 -------    ------   ------
Total Stockholders' Equity                        $3,556    $3,802   $3,178
                                                 =======    ======   ======























   The accompanying notes to consolidated financial statements are an integral
                           part of these statements.

                                       32
<PAGE>
CSW
CONSOLIDATED BALANCE SHEETS
CENTRAL AND SOUTH WEST CORPORATION
---------------------------------------------------------------------------
                                                          As of December 31,
                                                          -----------------
                                                            1997      1996
                                                          -------   -------
                                                              (millions)
ASSETS
Fixed Assets
    Electric
        Production                                         $5,824    $5,830
        Transmission                                        1,558     1,538
        Distribution                                        4,453     4,237
        General                                             1,381     1,318
        Construction work in progress                         184       230
        Nuclear fuel                                          196       184
                                                          -------   -------
                                                           13,596    13,337
    Other diversified                                         250        84
                                                          -------   -------
                                                           13,846    13,421
  Less - Accumulated depreciation and amortization          5,218     4,940
                                                          -------   -------
                                                            8,628     8,481
                                                          -------   -------
Current Assets
    Cash and temporary cash investments                        75       254
    Accounts receivable                                       916       837
    Materials and supplies, at average cost                   172       185
    Electric utility fuel inventory                            65       102
    Under-recovered fuel costs                                 84        46
    Prepayments and other                                      78        85
                                                          -------   -------
                                                            1,390     1,509
                                                          -------   -------
Deferred Charges and Other Assets
    Deferred plant costs                                      503       509
    Mirror CWIP asset                                         285       299
    Other non-utility investments                             448       371
    Securities available for sale                             103      --
    Income tax related regulatory assets, net                 329       236
    Goodwill                                                1,428     1,525
    Other                                                     337       402
                                                          -------   -------
                                                            3,433     3,342
                                                          -------   -------
                                                          $13,451   $13,332
                                                          =======   =======












       The accompanying notes to consolidated financial statements are an
                       integral part of these statements.

                                       33
<PAGE>
CSW
CONSOLIDATED BALANCE SHEETS
CENTRAL AND SOUTH WEST CORPORATION
----------------------------------------------------------------------
                                                  As of December 31,
                                                ----------------------
                                                  1997          1996
                                                --------      --------
CAPITALIZATION AND LIABILITIES                         (millions)
Capitalization
    Common stock:   $3.50 par value
        Authorized shares:   
                350.0 million shares
        Issued and outstanding: 
                212.2 million shares
          in 1997 and 211.5 million 
          shares in 1996                           $ 743         $ 740
    Paid-in capital                                1,039         1,022
    Retained earnings                              1,746         1,963
    Foreign currency translation and other            28            77
                                                --------      --------
                                                   3,556  45%     3,802  47%
                                                -------- ---  --------- ---
    Preferred Stock
        Not subject to mandatory redemption          176            292
        Subject to mandatory redemption               26             33
                                                --------      ---------
                                                     202   2%       325   4%
    Certain Subsidiary-obligated, 
       mandatorily redeemable preferred 
       securities of subsidiary trusts 
       holding solely Junior Subordinated 
       Debentures of such Subsidiaries               335   4%      --    --%
    Long-term debt                                 3,898  49%     4,024  49%
                                                -------- ---  --------- ---
          Total Capitalization                     7,991 100%     8,151 100%
                                                -------- ---  --------- ---

Current Liabilities
    Long-term debt and preferred stock 
      due within twelve months                        32           204
    Short-term debt                                  721           364
    Short-term debt - CSW Credit, Inc.               636           579
    Loan notes                                        56            76
    Accounts payable                                 558           630
    Accrued taxes                                    171           324
    Accrued interest                                  87            82
    Other                                            238           166
                                                --------      --------
                                                   2,499         2,425
                                                --------      --------

Deferred Credits
    Accumulated deferred income taxes              2,432         2,272
    Investment tax credits                           278           291
    Other                                            251           193
                                                --------      --------
                                                   2,961         2,756
                                                --------      --------
                                                $ 13,451      $ 13,332
                                                ========      ========









       The accompanying notes to consolidated financial statements are an
                       integral part of these statements.

                                       34
<PAGE>
CSW
CONSOLIDATED STATEMENTS OF CASH FLOWS
CENTRAL AND SOUTH WEST CORPORATION
-----------------------------------------------------------------------------
                                                For the Years Ended December 31,
                                                 ----------------------------
                                                   1997       1996      1995
                                                 -------    -------    ------
                                                           (millions)
OPERATING ACTIVITIES
    Net income for common stock                     $153       $429     $402
    Non-cash Items and Adjustments
        Depreciation and amortization                529        521      425
        Deferred income taxes and
          investment tax credits                     110         62      (11)
        Preferred stock dividends                     12         18       19
        Gain on reacquired preferred stock           (10)      --       --
        Mirror CWIP liability amortization          --         --        (41)
        Charges for investments and assets            53        147     --
        Gain on sale of subsidiary                  --         (192)    --
    Changes in Assets and Liabilities
        Accounts receivable                         (140)       (86)     (36)
        Accounts payable                              45         23      (32)
        Accrued taxes                               (153)       (14)      25
        Fuel recovery                                (37)       (89)      76
    Other                                            164         56      (28)
                                                 -------    -------    -----
                                                     726        875      799
                                                 -------    -------    -----
INVESTING ACTIVITIES
    Construction expenditures                       (507)      (521)    (474)
    Acquisitions expenditures                       --       (1,394)    (421)
    CSW Energy/CSW International projects           (382)      (124)     109
    Sale of National Grid assets                    --           99     --
    Cash proceeds from sale of subsidiary           --          690     --
    Other                                            (15)       (36)     (26)
                                                 -------    -------    -----
                                                    (904)    (1,286)    (812)
                                                 -------    -------    -----
FINANCING ACTIVITIES
    Common stock sold                                 20        477       57
    Proceeds from issuance of long-term debt        --          437      456
    SEEBOARD acquisition financing                  --          350      731
    Reacquisition/Maturity of long-term debt        (253)      (239)    (363)
    Redemption of preferred stock                   (114)        (1)      (1)
   Trust Preferred Securites Sold                    323       --       --
    Other financing activities                        (3)        67     --
    Change in short-term debt                        414       (395)    (226)
    Payment of dividends                            (383)      (376)    (348)
                                                 -------    -------    -----
                                                       4        320      306
                                                 -------    -------    -----

Effect of exchange rate changes on cash and
  cash equivalents                                    (5)       (56)    --
                                                 -------    -------    -----

Net Change in Cash and Cash Equivalents             (179)      (147)     293
Cash and Cash Equivalents at Beginning of Year       254        401      108
                                                 =======    =======    =====
Cash and Cash Equivalents at End of Year             $75       $254     $401
                                                 =======    =======    =====

SUPPLEMENTARY INFORMATION
    Interest paid less amounts capitalized          $396       $356     $301
                                                 =======    =======    =====
    Income taxes paid                               $301       $196      $77
                                                 =======    =======    =====

       The accompanying notes to consolidated financial statements are an
                       integral part of these statements.

                                       35
<PAGE>


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      Nature of Operations
      CSW is a registered  holding company under the Holding Company Act subject
to  regulation  by the SEC.  CSW's U.S.  Electric  Operating  Companies are also
regulated by the SEC under the Holding Company Act.

      The principal business of CSW's U.S. Electric  Operating  Companies is the
generation,  transmission,  and distribution of electric power and energy. These
companies  are subject to regulation by the FERC under the Federal Power Act and
follow the Uniform System of Accounts  prescribed by the FERC.  They are subject
to further regulation with regard to rates and other matters by state regulatory
commissions as follows: CPL and WTU are subject to the Texas Commission;  PSO is
subject to the  Oklahoma  Commission;  and  SWEPCO is  subject  to the  Arkansas
Commission, Louisiana Commission, Oklahoma Commission and Texas Commission.

      The  principal   business  of  CSW's  United  Kingdom  electric  operating
subsidiary,  SEEBOARD,  is the  distribution  and supply of  electric  power and
energy in Southeast England. SEEBOARD is subject to rate regulation by the DGES.

      In addition to electric utility operations,  CSW has subsidiaries involved
in a variety of business  activities.  CSW Energy and CSW  International  pursue
cogeneration and other energy-related  ventures; CSW Credit factors the accounts
receivable of affiliated and non-affiliated companies; C3 Communications pursues
telecommunications  projects;  CSW Leasing has investments in leveraged  leases;
EnerShop offers  energy-management  services and CSW Energy Services will pursue
retail energy markets outside of CSW's traditional service territory.

      The more significant  accounting policies of the CSW System are summarized
below.

      Principles of Consolidation
      The consolidated  financial statements include the accounts of CSW and its
subsidiary companies.

      Use of Estimates
      The  preparation  of financial  statements  in conformity  with  generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that affect the reported  amounts of assets and  liabilities  along
with  disclosure of contingent  liabilities at the date of financial  statements
and the reported  amounts of revenues and expenses during the reporting  period.
Actual results could differ from those estimates.

      Fixed Assets and Depreciation
      U.S.   Electric   fixed  assets  are  stated  at  the  original   cost  of
construction,  which  includes the cost of  contracted  services,  direct labor,
materials,  overhead  items and  allowances  for  borrowed and equity funds used
during  construction.  SEEBOARD's fixed assets are stated at their original fair
market value which existed on the date of acquisition  plus the original cost of
property acquired or constructed since the acquisition, less disposals.

      Provisions for depreciation of plant are computed using the  straight-line
method,  generally  at  individual  rates  applied  to the  various  classes  of
depreciable  property.  CSW's annual average  consolidated  composite rates were
3.4% for the years 1995-1997.

      CPL Nuclear Decommissioning of STP
      At the end of  STP's  service  life,  decommissioning  is  expected  to be
accomplished using the  decontamination  method,  which is one of the techniques
acceptable to the NRC. Using this method, the  decontamination  activities occur

                                       36
<PAGE>

as soon as possible after the end of plant operations. Contaminated equipment is
cleaned and removed to a permanent disposal location,  and the site is generally
returned to its pre-plant state.

      CPL's  decommissioning  costs are accrued and funded to an external  trust
over the  expected  service life of the STP units.  The  existing NRC  operating
licenses  will  allow the  operation  of STP Unit 1 until  2027 and Unit 2 until
2028. The accrual for decommissioning costs is an annual level cost based on the
estimated future cost to decommission  STP,  including  escalations for expected
inflation  to the  expected  time  of  decommissioning,  and is net of  expected
earnings on the trust fund.

      CPL's  portion of the costs of  decommissioning  STP were  estimated to be
$258 million in 1995 dollars based on a site specific  study  completed in 1995.
CPL is recovering these decommissioning costs through rates based on the service
life of STP at a rate of $8.2 million per year.  The $8.2 million annual cost of
decommissioning is reflected on the income statement in other operating expense.
Due to the fact that the funds are  deposited  with a trustee under the terms of
an irrevocable  trust and because of the ongoing nature of the FASB project,  as
described  below,  management  believes  it  inappropriate  to reflect the trust
assets on CSW's  financial  statements.  At December 31, 1997, the trust balance
was $45.7 million.

      The  FASB  is  currently  reviewing  the  utility  industry's   accounting
treatment of nuclear and certain other plant decommissioning  costs. An exposure
draft  regarding  this matter was issued in February  1996. In November 1997 the
FASB  abandoned all previous  decisions on the scope of this project and began a
new  project  related to  decommissioning  and other  environmental  remediation
costs. It is not known at this time when any new pronouncement would result from
this project.

      Electric Revenues and Fuel
      The  U.S.  Electric   Operating   Companies  record  revenues  based  upon
cycle-billings.  Electric service  provided  subsequent to billing dates through
the end of each calendar month are accrued for by estimating  unbilled  revenues
in accordance with industry standards.

      CPL,  SWEPCO  and WTU  recover  retail  fuel  costs  in  Texas  as a fixed
component of base rates whereby over-recoveries of fuel are payable to customers
and under-recoveries may be billed to customers after Texas Commission approval.
The  cost of fuel is  charged  to  expense  as  incurred,  with  resulting  fuel
over-recoveries   and   under-recoveries   recorded  as  regulatory  assets  and
liabilities.  PSO recovers fuel costs in Oklahoma and SWEPCO recovers fuel costs
in Arkansas and  Louisiana  through  automatic  fuel  recovery  mechanisms.  The
application of these mechanisms  varies by jurisdiction.  See NOTE 2. LITIGATION
AND REGULATORY PROCEEDINGS, for further information about fuel recovery.

      CPL, PSO and WTU recover  fuel costs  applicable  to wholesale  customers,
which are regulated by the FERC,  through an automatic fuel  adjustment  clause.
SWEPCO  recovers fuel costs  applicable to wholesale  customers  through formula
rates.

      CPL amortizes  direct nuclear fuel costs to fuel expense on the basis of a
ratio of the  estimated  energy  used in the core to the energy  expected  to be
derived from such fuel  assembly  over its life in the core. In addition to fuel
amortization,  CPL also records nuclear fuel expense as a result of other items,
including  spent fuel  disposal fees assessed on the basis of net MWHs sold from
STP and DOE special assessment fees for  decontamination  and decommissioning of
the enrichment facilities on the basis of prior usage of enrichment services.

      Accounts Receivable
      CSW  Credit,  as a wholly  owned  subsidiary  of CSW,  purchases,  without
recourse,  the billed and  unbilled  accounts  receivable  of the U.S.  Electric
Operating Companies,  certain non-affiliated public utility companies and, prior
to its sale by CSW in June 1996, Transok.

                                       37
<PAGE>

      Regulatory Assets and Liabilities
      For their regulated  activities,  the U.S.  Electric  Operating  Companies
follow SFAS No. 71,  which  defines the  criteria  for  establishing  regulatory
assets and regulatory  liabilities.  Regulatory assets represent probable future
revenue to the company  associated  with  certain  costs which will be recovered
from customers through the ratemaking process.  Regulatory liabilities represent
probable future refunds to customers.  The regulatory assets are currently being
recovered in rates or are probable of being recovered in rates.  The unamortized
asset balances are included in the table below.



<PAGE>


                                                    1997       1996
                                                  --------   ---------
             As of December 31,                        (millions)
              Regulatory Assets
              Deferred plant costs (1)              $503        $509
              Mirror CWIP asset                      285         299
              Income tax related regulatory         
                assets, net                          329         236
              Deferred restructuring and rate        
                case costs (2)                        36          46
              Deferred storm costs (3)                --           2
              OPEBs                                    3           3
              Demand side management costs            10          15
              Under-recovered fuel costs (4)          84          47
              Loss on reacquired debt                166         180
              Fuel settlement (5)                     16          17
              Other                                    8          13
                                                 --------   ---------
                                                  $1,440      $1,367
             Regulatory Liabilities
              Refunds due customers                  $64         $43
              Other                                    1           2
                                                 --------   ---------
                                                     $65         $45
                                                 --------   ---------

    (1)  $19 in 1997 and $22 in 1996 earning no return, amortized through 2002
    (2)  $24 in 1997 and $31 in 1996 earning no return, amortized by the end
         of 2000; $12 in 1997 and $15 in 1996 earning no return, amortized
         through 2002
    (3)  Item  earning no return,  amortized by the end of 1997 (4) $15 in 1997
         and $3 in 1996 earning no return, amortized over 12 month period,
         recalculated semiannually
    (5)  Item earning no return, amortized by the end of 2006


In accordance with orders of the Texas Commission, CPL and WTU deferred carrying
costs, as well as operating  costs,  depreciation and tax costs incurred for STP
and Oklaunion,  respectively.  These deferrals were for the period  beginning on
the date when the plants began  commercial  operation  until the date the plants
were included in rate base.  CPL is amortizing  and  recovering  these  deferred
costs  through  rates  over the life of the  plant.  WTU  began  amortizing  and
recovering  such costs over a seven year period  beginning  January 1, 1996.  In
accordance with Texas Commission orders,  CPL previously  recorded a Mirror CWIP
asset,  which is being  amortized over the life of STP. For further  information
regarding the deferred plant costs at CPL and WTU,  reference is made to NOTE 2.
LITIGATION AND REGULATORY  PROCEEDINGS.  For  additional  information  regarding
regulatory  accounting,  reference  is  made  to NEW  ACCOUNTING  STANDARDS  and
MD&A-RECENT DEVELOPMENTS AND TRENDS, Regulatory Accounting.

      SEEBOARD Acquisition
      The  acquisition of SEEBOARD was accounted for as a purchase  combination.
An allocation of the purchase  price has been  performed and is reflected in the
consolidated  financial  statements.  The  goodwill  is  being  amortized  on  a
straight-line  basis over 40 years.  The  unamortized  balance  of the  SEEBOARD
goodwill  at December  31,  1997 was $1.4  billion.  CSW  continually  evaluates
whether  circumstances  have occurred that indicate the remaining useful life of
goodwill may warrant revision or that the remaining  balance of goodwill may not
be recoverable.

                                       38
<PAGE>


      National Grid Assets
      Pursuant to a December 11, 1995 distribution by SEEBOARD, CSW (UK) plc, as
a  shareholder  of  SEEBOARD,  received  approximately  32.5  million  shares of
National Grid common stock.  On February 2, 1996,  all of these shares were sold
for approximately $99 million.

      Foreign Currency Translation
      The financial  statements of SEEBOARD U.S.A., which are included
in CSW's consolidated  financial  statements,  have been translated from British
pounds to U.S.  dollars  in  accordance  with SFAS No.  52.  All  balance  sheet
accounts are  translated  at the exchange  rate at the end of the period and all
income  statement  items are  translated  at the average  exchange  rate for the
applicable   period.  At  December  31,  1997  the  current  exchange  rate  was
approximately  (pound)1.00=$1.65,  and the average  exchange rate for the twelve
month period ended  December 31, 1997 was  approximately  (pound)1.00=$1.58.  At
December 31, 1996 the current exchange rate was approximately (pound)1.00=$1.71,
and the average  exchange  rate for the twelve month  period ended  December 31,
1996 was  approximately  (pound)1.00=$1.56.  The average  exchange  rate for the
twelve month period ended December 31, 1995 was approximately (pound)1.00=$1.58.
All resulting translation  adjustments are recorded directly to Foreign currency
translation and other on CSW's Consolidated  Balance Sheets. Cash flow statement
items are  translated  at a  combination  of  average,  historical  and  current
exchange rates. The non-cash impact of the changes in exchange rates on cash and
cash  equivalents,  resulting  from the  translation  of items at the  different
exchange  rates,  is shown on CSW's  Consolidated  Statements  of Cash  Flows in
Effect of exchange rate changes on cash and cash equivalents.

      Statements of Cash Flows
      Cash  equivalents  are considered to be highly liquid  instruments  with a
maturity of three months or less.  Accordingly,  temporary cash  investments are
considered cash equivalents.

      Risk Management
      CSW has been exposed to currency and interest rate risks which reflect the
floating exchange rate that exists between the U.S. dollar and the British pound
since its purchase of SEEBOARD in 1995. CSW has utilized certain risk management
tools,  including cross currency  swaps,  foreign  currency  futures and foreign
currency options,  to manage adverse changes in exchange rates and to facilitate
financing transactions resulting from CSW's acquisition of SEEBOARD.

      SEEBOARD has entered into contracts for  differences to reduce exposure to
fluctuations  in the price of electricity  purchased  from the United  Kingdom's
electricity power pool. This pool was established at privatization of the United
Kingdom's  electric  industry  for  the  bulk  trading  of  electricity  between
generators and suppliers.

      CSW accounts for these transactions as hedge transactions and any gains or
losses associated with the risk management tools are recognized in the financial
statements  at the time the hedge  transactions  are  settled.  CSW believes its
credit risk in these contracts is negligible. See MD&A, RISK MANAGEMENT and NOTE
7. FINANCIAL INSTRUMENTS for additional information.

      Securities Available for Sale
      CSW accounts for its  investments in equity  securities in accordance with
SFAS No. 115. The investments have been designated as available for sale, and as
a result are stated at fair value.  Unrealized  holding gains and losses, net of
related taxes,  are included  within Foreign  currency  translation and other on
CSW's  Consolidated  Balance  Sheets.  Information  related to these  Securities
available for sale as of December 31, 1997 is presented in the following table.

                                       39
<PAGE>

                                Original         Unrealized
                                  Cost      Holding Gains/(Losses)   Fair Value
                                -----------------------------------------------
                                                  (millions)

Securities available for sale     $110          $5         $(12)       $103


      Accounting Change
      Effective January 1, 1997, CPL and WTU began utilizing the LIFO method for
the  valuation  of all fossil  fuel  inventories.  Previously,  CPL had used the
weighted  average  cost method and WTU had used the LIFO method for coal and the
weighted average cost method for other fuel  inventories.  PSO utilizes the LIFO
method.  SWEPCO  continues to utilize the weighted  average cost method  pending
approval of the Arkansas  Commission to utilize the LIFO method. The  change  in
accounting  did  not  affect the  results  of  operations  due to the regulatory
treatment of such costs.

      Reclassification
      Certain  financial  statement items for prior years have been reclassified
to  conform  to  the  1997  presentation.  See  NOTE  15.  TRANSOK  DISCONTINUED
OPERATIONS for information related to the classification of Transok activities.


2.    LITIGATION AND REGULATORY PROCEEDINGS

      Settlement of Litigation  Related to  Termination of El Paso Merger
      In May 1993, CSW entered into a merger agreement pursuant to which El Paso
would have emerged from bankruptcy as a wholly owned  subsidiary of CSW. In June
1995,  following its  notification  that CSW was  terminating the El Paso Merger
Agreement,  El Paso filed suit against CSW seeking a $25 million termination fee
from CSW, as well as, unspecified  damages for various contract and tort claims.
Subsequently,  CSW filed suit against El Paso seeking a $25 million  termination
fee from El Paso and recovery of certain rate case  expenses  incurred by CSW on
behalf of El Paso.

      The United  States  Bankruptcy  Court for the  Western  District of Texas,
Austin  Division,  consolidated  the El Paso  suit  and the CSW  suit  into  one
adversary  proceeding.  On April 11, 1997,  the court issued an interim order in
which it ruled that CSW owed El Paso a $25 million  termination fee and reserved
judgment on certain disputed interest.

      In July 1997, CSW and El Paso reached a settlement agreement that resolved
all of the pending litigation.  Under the terms of the settlement agreement, CSW
and El Paso  dismissed  all pending  claims in the  litigation  and CSW paid $35
million  to  El  Paso,  various  of  its  creditor  groups  under  its  plan  of
reorganization,  and its attorneys.  CSW recorded a charge of $25 million in the
first  quarter of 1997  following  the  court's  interim  order and  recorded an
additional  charge  of $10  million  in the  second  quarter  of 1997  to  fully
recognize the $35 million  settlement  amount.  The bankruptcy court vacated the
interim order and approved the settlement agreement.

      Litigation Related to the Rights Plan and AEP Merger
      Two lawsuits have been filed in Delaware state court seeking to enjoin the
AEP Merger.  CSW and each of its directors have been named as defendants in both
cases. The first suit alleges that the Rights Plan, approved by the CSW Board of
Directors on September  27, 1997 and which became  effective  after SEC approval
under the Holding Company Act on December 19, 1997,  constitutes a "poison pill"
precluding  acquisition  offers and resulting in a heightened  fiduciary duty on
the part of the CSW Board of Directors to pursue an  auction-type  sales process
to obtain the best value for CSW stockholders.  The second suit alleges that the
AEP  Merger is  unfair to CSW  stockholders  in that it does not  recognize  the
underlying  intrinsic  value of CSW's assets and its future  profitability.  The
second suit also seeks an  auction-type  sale  process.  CSW believes  that both
suits are without merit and intends to defend them vigorously.

                                       40
<PAGE>

      CPL Rate Review - Docket No. 14965
      In  November  1995,  CPL filed  with the  Texas  Commission  a request  to
increase its retail base rates by $71 million, and in May 1996, CPL placed a $70
million base rate  increase  into effect under bond,  subject to refund based on
the receipt of a final order of the Texas  Commission.  On March 31,  1997,  the
Texas  Commission  issued the CPL 1997 Original Rate Order in CPL's rate review,
Docket No. 14965.  Thereafter,  CPL filed a motion for rehearing which requested
the reconsideration of numerous  provisions of the order.  Motions for rehearing
were also filed by other  parties to the rate  proceeding.  In  response  to the
motions  for  rehearing,  in  June  1997,  the  Texas  Commission  made  several
modifications  to the CPL 1997  Original Rate Order and also agreed to rehear on
remand  several  other  issues.  CPL restored  its rates in July 1997,  with two
exceptions,  to levels existing prior to the May 1996  implementation  of bonded
rates. On August 21, 1997, after  reconsidering the issues on remand,  the Texas
Commission  voted to issue a revised final order and on September 10, 1997,  CPL
received a revised  final order.  CPL filed its second  motion for  rehearing on
September  30,  1997.   The  second  motion  for   rehearing   again   requested
reconsideration  of  numerous  issues in the rate case.  On October 16, 1997 the
Texas  Commission  issued the CPL 1997  Final  Order.  The CPL 1997 Final  Order
lowers the annual  retail base rates of CPL by  approximately  $19  million,  or
2.5%,  from CPL's rate level existing  prior to May 1996.  The Texas  Commission
also  included a "Glide  Path"  rate  methodology  in the CPL 1997  Final  Order
pursuant  to which  CPL's  annual  rates will be reduced  by an  additional  $13
million in mid-1998 and another $13 million in mid-1999.

      The CPL 1997 Original Rate Order established a separate docket, Docket No.
17280,  to consider  the  recoverability  of $20  million of rate case  expenses
incurred  in the  current  rate case and in two  prior  dockets.  CPL  reached a
settlement  with all parties to resolve  Docket No. 17280 which provides for CPL
to  recover  $14  million  out of the total $20  million  of rate case  expenses
originally requested. Approximately $8 million of the rate case expenses will be
recovered  as an offset to the refund in the rate  case,  and the  remaining  $6
million of expenses  will be  surcharged  to  customers  over three  years.  CPL
expensed the $6 million in foregone rate case expenses  during the first quarter
of 1997.

      CPL  implemented  bonded rates  subject to refund in May 1996. On July 17,
1997, CPL restored its rates,  with two exceptions,  to levels existing prior to
the  implementation  of the bonded rates.  The two exceptions are for industrial
interruptible  rates and customer service charges for which the Texas Commission
approved the increases requested by CPL. On October 31, 1997, CPL filed with the
Texas  Commission  a proposed  methodology  for  issuing  an  interim  refund to
customers  in  December  1997.  A second  refund  was made in  March  1998.  The
different  components that were all  incorporated  into the December 1997 refund
made to customers, a breakdown of the December 1997 refund, as well as the March
1998 refund, including interest, is shown below (millions).

          December 1997
          Amount collected from customers under bond     $81.7
          Surcharge for rate case expenses               (13.3)
          Surcharge for fuel cost under-recovery         (23.6)
                                                       ---------
          Net refund to customers                        $44.8
                                                       ---------

          March 1998 (estimated)
          Remaining refund available                     $59.0
          Anticipated surcharge for fuel                 
          cost under-recovery                            (34.3)
                                                       ---------
          Net refund to customers                        $24.7
                                                       ---------

      The following  table  details the  financial  impact of the CPL 1997 Final
Order as compared to the rates  existing  prior to CPL placing bonded rates into
effect.  Although the entire  impact has been  recorded in CSW's 1997 results of
operations,  the financial  impact on its results of operations for 1996 and for
the year 1997 is shown below.

                                       41
<PAGE>

                                                  1996
                                               Retroactive  1997 Only
                                                 Impact      Impact
                                               ----------  ----------
                                                     (millions)
          Decrease in revenue                    $(20.7)     $(24.2)
                                                ----------  ----------
          Items included in decrease in
           revenue with offsetting effect 
           on expense:
           Accelerated recovery of STP (ECOM)      13.3        20.0

          Change in depreciation                   (7.5)      (11.3)
          Decommissioning                           1.9         4.3
          Other                                     --          6.8
                                                ----------  ----------
                                                    7.7        19.8
                                                ----------  ----------
         Change in current year income before     (28.4)      (44.0)
           tax
         Federal income taxes                       9.5        14.8
                                                ----------  ----------
         Impact on net income - all       
          recorded in 1997                       $(18.9)     $(29.2)
                                                ----------  ----------

      CPL  appealed  the CPL 1997  Final  Order to the State  District  Court of
Travis  County to challenge the  resolution of several  issues in the rate case.
The primary issues include:  (i) the  classification of $800 million of invested
capital in STP as ECOM which was also  assigned  a lower  return on equity  than
non-ECOM  property,  (ii) the Texas  Commission's  use of the "Glide  Path" rate
reduction methodology to be applied to rates in mid-1998 and mid-1999, and (iii)
the $18 million of disallowed affiliate  transactions from CSW Services. As part
of the appeal, CPL seeks a temporary injunction to prohibit the Texas Commission
from  implementing  the  "Glide  Path"  rate  reduction  methodology,  currently
scheduled  to begin  in May  1998.  A  hearing  has  been set for the  temporary
injunction  on April 3,  1998.  Management  is unable to  predict  how the final
resolution  of these issues will  ultimately  affect CSW's results of operations
and financial condition.

      See MD&A - RATES AND  REGULATORY  MATTERS,  CPL Rate  Review - Docket  No.
14965 for  additional  discussion  of the CPL 1997 Final  Order,  including  the
estimated ongoing financial impact of the final order and information  regarding
the difference  between the rates originally  requested by CPL and those ordered
by the Texas Commission.

      CPL 1995 Agreement
      On April 5, 1995, CPL reached an agreement in principle with other parties
to pending regulatory  proceedings involving base rate, fuel and prudence issues
relating to an outage  experienced  at STP during  1993 and 1994.  Under the CPL
1995  Agreement,  CPL  provided  customers  a one-time  base rate  refund of $50
million. In addition,  CPL refunded  approximately $30 million in over-recovered
fuel costs through  April 1995.  Furthermore,  CPL did not charge  customers for
$62.25  million  in  replacement  power  costs and  related  interest  primarily
associated with the 1993-1994 STP outage.  The CPL 1995 Agreement did not result
in any ongoing  change in base rate levels and  provided  that there would be no
new rate review requests filed prior to September 28, 1995. CPL also reduced its
fuel factors,  effective in July 1995, by approximately $55 million on an annual
basis due to projections of lower fuel costs. The Texas Commission  approved the
CPL 1995  Agreement  on October  4,  1995.  Details of the items in the CPL 1995
Agreement  and the total 1995  earnings  impact,  including  certain  accounting
provisions, are set forth in the following table.


                                       42
<PAGE>


                                           Pre-tax  After-tax
                                           ------------------
                                              (millions)

     Base rate refund                      $(50.0)   $(32.5)
     Fuel disallowance                      (62.3)    (40.5)
     Wholesale fuel refund                   (3.2)     (2.1)
     Current flowback of excess deferred
      federal income taxes                   34.3      34.3
     Capitalization of previously expensed
      restructuring and rate case costs      27.6      17.9
     
     Recognition of factoring income         16.1      10.5
     Amortization, interest and other        (6.6)     (4.4)


      CPL Deferred Accounting
      By orders issued in 1989 and 1990, the Texas Commission  authorized CPL to
defer  certain  STP  Unit 1 and Unit 2 costs  incurred  between  the  commercial
operation  dates of those units and the effective  date of rates  reflecting the
operation of those units. Upon appeal of the 1989 CPL order, and a related order
involving another utility, the Supreme Court of Texas in 1994 sustained deferred
accounting  as an  appropriate  mechanism  for the  Texas  Commission  to use in
preserving the financial  integrity of CPL, but remanded CPL's case to the Court
of  Appeals  to  consider  certain  substantial  evidence  points  of error  not
previously  decided by the Court of Appeals.  On August 16,  1995,  the Court of
Appeals  rendered  its opinion in the remand  proceeding  and affirmed the Texas
Commission's order in all respects.

      By orders issued in October 1990 and December 1990,  the Texas  Commission
quantified  the STP Unit 1 and Unit 2 deferred  accounting  costs and authorized
the inclusion of the  amortization  of the costs and associated  return in CPL's
retail rates.  These Texas Commission  orders were appealed to the Travis County
District  Court  where the appeals  are still  pending.  Language in the Supreme
Court of Texas' opinion in the appeal of the deferred  accounting  authorization
case suggests that the appropriateness of including deferred accounting costs in
rates  charged to customers is dependent on a finding in the first case in which
the  deferred  STP costs are  recovered  through  rates  that the  deferral  was
actually  necessary to preserve the  utility's  financial  integrity.  If in the
appeals of the October 1990 and December  1990 rate  orders,  the courts  decide
that subsequent  review under the financial  integrity  standard is required and
was not made in those  orders,  such rate orders  would be remanded to the Texas
Commission for the purpose of entering findings applying the financial integrity
standard.  Pending the ultimate  resolution of CPL's deferred accounting issues,
CPL is unable to predict how its deferred  accounting  orders will ultimately be
resolved by the Texas Commission.

      If CPL's deferred accounting matters are not favorably resolved, CSW could
experience a material  adverse effect on its results of operations and financial
condition.  While CPL's  management is unable to predict the ultimate outcome of
these matters,  management believes either that CPL will receive approval of its
deferred  accounting  amounts or that CPL will be successful in renegotiation of
its rate  orders,  so that there  will be no  material  adverse  effect on CSW's
results of operation or financial condition.

      CPL Fuel Proceeding
      In January 1998, CPL filed a request with the Texas  Commission to recover
approximately  $41.4 million in uncollected  fuel and purchased  power costs and
related interest from its retail customers and to increase the fuel factors used
to  recover  fuel costs  incurred  to provide  service in the  future.  The fuel
surcharge  will be  subtracted  from the  remaining  base rate  refund  totaling
approximately  $59.0  million that was ordered by the Texas  Commission in CPL's
recent general rate case, Docket No. 14965. This net refund is being issued as a
one-time  adjustment to customers' March 1998 bills. In the same filing with the
Texas  Commission,  CPL also  requested  permission  to increase  its fixed fuel
factors by  approximately  $23.4 million  effective  with March 1998 bills.  The
primary cause of CPL's current fuel cost under-recovery and the need to increase
its current fuel factors is the  unanticipated  increase in the price of natural
gas.

                                       43
<PAGE>

      In February  1998,  stipulations  were reached on both the fuel factor and
surcharge.  The fuel factor increase is being reduced to $15.4 million,  and the
fuel  surcharge  including  interest  is being  reduced  to $34.3  million.  The
reductions are not a  disallowance  and will be considered as part of CPL's fuel
reconciliation filing to be made in December 1998.

      CPL Nuclear Insurance Claims
      In  1994,  CPL  filed a claim  under  its NEIL I  policy  relating  to the
1993-1994  outage at STP Units 1 and 2. NEIL  denied  CPL's  claim in 1995.  CPL
filed an action in April 1996  against both NEIL and Johnson & Higgins of Texas,
Inc., the former insurance broker for STP, seeking recovery under the policy and
other  relief.  Subsequently,  CPL and NEIL  agreed to  dismiss  all  litigation
between them concerning CPL's claim for NEIL coverage, and they agreed to submit
their  disputes  over coverage to a  non-binding,  neutral  evaluation  process.
Hearings were held by the neutral  evaluator in February 1997 and April 1997. On
April 22, 1997, the neutral evaluator made the  recommendation  that CPL's claim
was not covered by its NEIL I policy. CPL abided by this recommendation.

      CPL Industrial Road and Industrial Metals Site
      Three suits naming CPL and others as defendants  relating to a third-party
owned and operated site in Corpus  Christi,  Texas  formerly used for commercial
reclamation of used electrical transformers, lead acid batteries and other scrap
metals,  were pending in federal and state court in Corpus Christi,  Texas.  The
plaintiffs'  complaints  sought damages for alleged  property  damage and health
impairment as a result of operations on the site and cleanup activities.  During
1997,  these suits were settled with no material adverse effect on CSW's results
of operation or financial condition.

      CPL Municipal Franchise Fee Litigation
      In May 1996, the city of San Juan, Texas filed a purported class action in
Hidalgo County, Texas District Court on behalf of all cities served by CPL based
upon CPL's alleged  underpayment  of municipal  franchise  fees. The plaintiff's
petition asserts various contract and tort claims against CPL as well as certain
audit rights. The suit seeks unspecified  damages and attorneys' fees. CPL filed
a counterclaim for any overpayment of franchise fees it may have made as well as
its attorneys' fees. CPL also filed a motion to transfer venue to Nueces County,
Texas, and a plea to the jurisdiction and pleas in abatement  asserting that the
Texas  Commission  has primary  jurisdiction  over the  claims.  In May 1996 and
December 1996,  respectively,  the cities of Pharr, Texas and San Benito,  Texas
filed individual suits making claims virtually identical to those claimed by the
city of San Juan. In January,  1997, CPL filed an original petition at the Texas
Commission  requesting  the Texas  Commission to declare its  jurisdiction  over
CPL's collection and payment of municipal franchise fees.

      In April 1997, the Texas Commission issued a declaratory order in which it
declined  to assert  jurisdiction  over the claims of the City of San Juan.  CPL
appealed the Texas  Commission's  decision to the Travis County,  Texas District
Court.  After the Texas  Commission's  order, the Hidalgo County court overruled
CPL's plea to the jurisdiction and plea in abatement.  In July 1997, the Hidalgo
County  court  entered  an  order  certifying  the case as a class  action.  CPL
appealed this order to the Corpus  Christi Court of Appeals.  In February  1998,
the court of appeals' affirmed the trial court's order certifying the class. CPL
appealed the court of appeals ruling to the Texas Supreme Court.

      Although  CPL  believes  that it has  substantial  defenses to the cities'
claims and intends to defend  itself  against the cities'  claims and pursue its
counterclaims  vigorously,  management  cannot  predict  the  outcome  of  these
lawsuits.


                                       44
<PAGE>


      CPL and WTU Texas Utilities Complaint (Docket No. 17285)
      A Proposal for Decision was received in February 1998 in a joint CPL/WTU
complaint at the Texas  Commission  that since January 1, 1997,  Texas Utilities
was  effectively  double charging for  transmission  service within the Electric
Reliability  Council of Texas.  The  Proposal  recommends  approval of a CPL/WTU
proposed  offset of $15.5 million  annually of payments to Texas Utilities under
FERC-approved  transmission  service agreements against amounts that CPL and WTU
would  otherwise  owe Texas  Utilities  pursuant to Texas  Commission  rules for
transmission  service in ERCOT.  The Texas Commission will consider the Proposal
in April 1998.

      PSO Rate Review
      In July 1996, the Oklahoma Commission staff filed an application seeking a
review of PSO's  earnings.  In accordance  with the  established  schedule,  PSO
subsequently  filed financial  data,  cost of service and rate design  testimony
supporting both its current rates and an increase in annual depreciation expense
of  $26  million.  In  July  1997,  the  Oklahoma  Commission  staff  and  other
intervenors to the proceeding filed their revenue requirements testimony. In its
filing,  the Oklahoma  Commission  staff  recommended a rate  reduction of $76.8
million for PSO.

      On October 15, 1997,  PSO reached a stipulated  agreement  with parties to
settle the rate inquiry  that was pending  before the  Oklahoma  Commission.  On
October 23, 1997,  the Oklahoma  Commission  issued a final order  approving the
agreement.  The PSO 1997 Rate  Settlement  Agreement  calls for PSO to lower its
retail  base  rates   beginning   with  the  December   1997  billing  cycle  by
approximately  $35.9  million  annually,  or a 5.3  percent  decrease  below the
current level of retail rates.  Part of the rate reduction  includes a reduction
in annual depreciation expense of approximately $10.9 million. In addition,  the
PSO 1997 Rate Settlement Agreement resulted in PSO making a one-time $29 million
refund to customers in December 1997.

      The PSO 1997 Rate Settlement  Agreement also calls for PSO to eliminate or
amortize  before  its next rate  filing  approximately  $41  million  in certain
deferred assets,  approximately  $26 million of which had been expensed in 1996.
The remaining $15 million of deferred  assets,  which included  approximately $9
million of costs incurred for customer  energy  management  incentive  programs,
were written off in 1997. The following table represents the financial impact of
the PSO 1997 Rate Settlement Agreement on CSW's 1997 results of operations.

                                                1997
                                                Impact
                                              ----------
                                              (millions)
          Decrease in revenues
             Refund to customers                $(29.0)
             Change in rates                      (2.5)
                                              ----------
                                                 (31.5)
                                              ----------

         Changes in expenses (offsetting 
            impact included in revenues)
            Depreciation                          (6.3)
            Rate case deferred costs               2.2
            Income tax                           (10.2)
                                              ----------
                                                 (14.3)
                                              ----------
                                                 (17.2)
        Write-off of deferred assets, net of     (10.2)
            tax
                                              ----------
                                                $(27.4)
                                              ----------

      The PSO 1997 Rate  Settlement  Agreement  resulted in an adverse effect on
CSW's results of operations for 1997 that will have a continuing  impact because
of the rate decrease.  However,  it reduced significant risks for PSO related to
this  regulatory  proceeding and should allow PSO's rates to remain  competitive
for the foreseeable future.

                                       45
<PAGE>

      See  MD&A -  RATES  AND  REGULATORY  MATTERS,  PSO  1997  Rate  Settlement
Agreement for additional  discussion of the PSO 1997 Rate Settlement  Agreement,
including the estimated ongoing financial impact of the agreement.

      PSO PCB Cases
      PSO has been  named a  defendant  in  petitions  filed  in state  court in
Oklahoma in February and August,  1996. The petitions allege that the plaintiffs
suffered  personal injury and fear future injury as a result of contamination by
PCBs from a transformer  malfunction  that  occurred in April,  1982 at the Page
Belcher  Federal  Building in Tulsa.  Each of the  plaintiffs  seeks  actual and
punitive  damages in excess of $10,000.  As  previously  reported,  other claims
arising from this incident have been settled and the suits dismissed. Management
believes that PSO has defenses to the remaining complaints and intends to defend
the suits vigorously.  Management believes that the remaining claims are covered
by  insurance.  Management  also  believes  that the ultimate  resolution of the
remaining  lawsuits will not have a material  adverse effect on CSW's results of
operations or financial condition.

      PSO Sand Springs/Grandfield, Oklahoma Sites
      In 1989,  PSO found PCB  contamination  in a Sand  Springs,  Oklahoma  PCB
storage facility. The EPA-approved cleanup began in 1994. In 1996, the EPA filed
a complaint  against PSO alleging  that PSO failed to comply with  provisions of
the Toxic Substances  Control Act. The EPA alleged improper  disposal of PCBs at
the Sand  Springs  site  due to the  length  of time  between  discovery  of the
contamination  and the actual  cleanup at the site.  The complaint  also alleged
failure to date PCB articles at a Grandfield,  Oklahoma site. The total proposed
penalty,  which was accrued by PSO in 1996, was $479,000. PSO settled all claims
in the suit by March 1998. The settlement did not have a material adverse effect
on CSW's results of operations or financial condition.

      SWEPCO Fuel Proceeding
      In April  1997,  SWEPCO  filed with the Texas  Commission  an  application
concerning  fuel  cost  under-recoveries  and a  possible  fuel  surcharge.  The
application  included a motion to either abate the requested  interim  surcharge
and  consolidate  the surcharge  with a filed fuel  reconciliation  as discussed
below, or  alternatively,  implement an interim  surcharge in the months of July
1997 through June 1998. The Texas Commission's Office of Policy Development,  on
behalf of the Texas Commission,  approved the  consolidation.  In addition,  the
Texas  Commission  has  waived  the  requirement  for  SWEPCO  to file  biannual
surcharge  requests  while this  proceeding  is pending,  and has  deferred  the
implementation of any surcharge and interest until after final disposition.

      In May 1997,  SWEPCO filed with the Texas  Commission  an  application  to
reconcile  fuel  costs  and  implement  a  12  month   surcharge  of  fuel  cost
under-recoveries.  Because  of  the  uncertainty  as to  when  a  surcharge  may
commence,  SWEPCO did not establish in its filing a proposed surcharge period or
a total  surcharge  amount  which  would  reflect  interest  through  the entire
surcharge period. However, SWEPCO indicated that it had an under-recovered Texas
jurisdictional  fuel cost  balance of  approximately  $16.8  million,  including
interest through  December 1996.  Included in the $16.8 million balance are fuel
related  litigation  expenses of $5.0  million  and an  interest  return of $2.0
million on the unamortized balance of a fuel contract termination payment.

      On  December  8,  1997,   SWEPCO  and  the  other  parties  to  the  above
consolidated  proceedings  before the Texas Commission filed a settlement on all
issues except for one issue which will be decided by the Texas  Commission.  The
outstanding issue concerns  transmission  equalization payments and whether they
should be  included  in fuel or base  revenues.  The  settlement  is  subject to
approval by the Texas Commission.  Of the $16.8 million in under-recovered  fuel
costs as of December 31, 1996, the settlement  would result in a decrease of the
under-recovered   fuel  costs,  and  the  resulting   surcharge   recovery,   by
approximately $6.0 million.  This disallowance will not result in an increase to
fuel  expense  since the $5.0  million of  litigation  expense and the  interest
return  of  $2.0  million  included  in  the  requested  surcharge  amount  were
previously  expensed.  However,  should  SWEPCO not  prevail on the  outstanding
issue,  SWEPCO  would be  required  to reduce  earnings  by  approximately  $1.8
million.  The  settlement  also provides  that  SWEPCO's  fuel and  fuel-related

                                       46
<PAGE>

expenses  during the  reconciliation  period were  reasonable  and necessary and
would  allow them to be  reconciled  as  eligible  fuel.  Also,  the  settlement
provides that  SWEPCO's  actions in litigating  and  renegotiating  certain fuel
contracts,  together with the prices,  terms and conditions of the  renegotiated
contracts were prudent.  The $6.0 million  reduction is not associated  with any
particular  activity or issue  within the fuel  proceedings.  Management  cannot
predict  whether  approval  of the  settlement  will  be  granted  by the  Texas
Commission.

      SWEPCO Burlington Northern Transportation Contract
      In January 1995, a state district court in Bowie County, Texas entered
judgment in favor of SWEPCO against  Burlington  Northern in a lawsuit regarding
rates  charged under two rail  transportation  contracts for delivery of coal to
SWEPCO's  Welsh  and Flint  Creek  power  stations.  The  court  awarded  SWEPCO
approximately   $72  million  that  would  benefit   customers,   if  collected,
representing  damages for the period from April 27, 1989 through  September  26,
1994, as well as post-judgment  interest and attorneys' fees and granted certain
declaratory relief requested by SWEPCO.  Burlington  Northern appealed the state
district court's judgment to the Texarkana, Texas Court of Appeals and, in April
1996,  that court reversed the judgment of the state district  court. In October
1996,  SWEPCO filed an  application  with the Supreme  Court of Texas to grant a
writ of error to review and reverse the judgment of the  Texarkana,  Texas Court
of  Appeals.  In  June  1997,  the  Supreme  Court  of  Texas  granted  SWEPCO's
application  for writ of error.  Oral argument was held before the Supreme Court
of Texas in October 1997. On March 13, 1998, the Supreme Court of Texas affirmed
the judgment of the court of appeals.

      SWEPCO Lignite Mining Agreement Litigation
      SWEPCO and CLECO are each a 50% owner of Dolet Hills Power  Station Unit 1
and  jointly  own  lignite  reserves  in the Dolet  Hills area of  northwestern
Louisiana.  In 1982,  SWEPCO and CLECO entered into a lignite  mining  agreement
with the DHMV,  a  partnership  for the mining and  delivery  of lignite  from a
portion of these reserves.

      On April 15,  1997,  SWEPCO  and CLECO  filed  suit  against  DHMV and its
partners  in the  United  States  District  Court for the  Western  District  of
Louisiana  seeking to enforce  various  obligations  of DHMV to SWEPCO and CLECO
under the lignite mining agreement, including provisions relating to the quality
of the delivered lignite,  pricing, and mine reclamation practices.  On June 15,
1997,  DHMV  filed an answer  denying  the  allegations  in the suit and filed a
counterclaim asserting various contract-related claims against SWEPCO and CLECO.
SWEPCO and CLECO have denied the allegations in the counterclaims.

      SWEPCO intends to vigorously  prosecute the claims against DHMV and defend
against the counterclaims  which DHMV has asserted.  Although  management cannot
predict  the  ultimate  outcome of this  matter,  management  believes  that the
resolution  of this  matter  will not have a  material  adverse  effect on CSW's
results of operations or financial condition.

      WTU Fuel Proceedings
      In March 1997,  WTU filed with the Texas  Commission  an  Application  for
Authority to Implement an increase in fuel factors of $4.2 million,  or 4.2%, on
an annual  basis.  Additionally,  WTU proposed to implement a fuel  surcharge of
$13.3 million,  including  accumulated  interest,  over a twelve month period to
collect its under-recovered fuel costs. WTU requested authority to implement the
revised fuel factors  with its May 1997  billings and to commence the  surcharge
with its June 1997  billings.  On April 14, 1997,  an agreement in principle was
reached among the parties to settle this docket.  Under the proposed settlement,
WTU agreed not to increase the fuel factors and to implement  the $13.3  million
surcharge  over the  period  from June 1997  through  February  1999.  The Texas
Commission approved the settlement in May 1997.

      On December 31, 1997,  WTU filed with the Texas  Commission an application
to reconcile  fuel costs and to request  authorization  to carry the  reconciled
balance  forward  into  the  next  reconciliation  period.  WTU did  not  seek a
surcharge of the reconciled balance in the December 31, 1997 filing.

                                       47
<PAGE>

      During the reconciliation period of July 1, 1994 through June 30, 1997 WTU
incurred  approximately $418 million in eligible fuel and fuel-related  expenses
to generate and purchase  electricity.  The Texas  jurisdictional  allocation of
such fuel and fuel-related expenses is approximately $292 million.

      In March 1998,  WTU filed with the Texas  Commission  an  Application  for
Authority to Implement an increase in fuel factors of $7.4 million,  or 7.3%, on
an annual  basis.  Additionally,  WTU proposed to implement a fuel  surcharge of
$6.8 million, including accumulated interest, over a six month period to collect
its under-recovered fuel costs. WTU requested authority to implement the revised
fuel factors and to commence the surcharge with its June 1998 billings.

      WTU 1995 Stipulation and Agreement
      The WTU 1995  Stipulation  and  Agreement  which was approved by the Texas
Commission in October 1996 has affected WTU's results of operations for 1996 and
1997. Details of the items with significant  earnings impact for 1995, including
certain accounting treatments, are set forth in the following table.

                                                Pre-ta After-tax
                                                ----------------
                                                   (millions)

     Refund to retail customers                  $(21.0)$(13.7)
     Effect of retail rate reduction               (2.4)  (1.6)
     Current flowback of property related excess   
       deferred federal income taxes                6.9    6.9
     Five year flowback of non-property related
       excess deferred federal income taxes         0.1    0.1
     Capitalization and amortization of
       previously expensed restructuring costs     12.7    8.2
     Other amortization                            (0.2)  (0.1)
     Other one-time items                           1.0    0.7

      The WTU 1995 Stipulation and Agreement also eliminated several significant
risks that have been the subject of regulatory  proceedings relating to deferred
accounting and rates and will enable WTU's rates to remain at competitive levels
for the foreseeable future.

      Other
      CSW is party to various other legal claims, actions and complaints arising
in the normal  course of business.  Management  does not expect  disposition  of
these matters to have a material  adverse  effect on CSW's results of operations
or financial condition.


3.    COMMITMENTS AND CONTINGENT LIABILITIES

      Construction and Capital Expenditures

      It is estimated that CSW, including the U.S. Electric Operating Companies,
SEEBOARD and other diversified operations, will spend approximately $569 million
in  capital  expenditures  (but  excluding  capital  that  may be  required  for
acquisitions) during 1998. Substantial  commitments have been made in connection
with these programs.

      Fuel and Related Commitments

      To  supply  a  portion  of their  fuel  requirements,  the  U.S.  Electric
Operating Companies have entered into various commitments for the procurement of
fuel.

                                       48
<PAGE>

      SWEPCO Henry W. Pirkey Power Plant
      In connection  with the South  Hallsville  lignite mining contract for its
Henry W. Pirkey Power Plant,  SWEPCO has agreed,  under certain  conditions,  to
assume the  obligations of the mining  contractor.  As of December 31, 1997, the
maximum  amount  SWEPCO  believes it could  potentially  assume is $67  million.
However,  the maximum amount may vary as the mining  contractor's need for funds
fluctuates.  The contractor's actual obligation outstanding at December 31, 1997
was $59 million.

      SWEPCO South Hallsville Lignite Mine
      As part of the process to receive a renewal of a Texas Railroad Commission
permit for lignite  mining at the South  Hallsville  lignite mine and  expansion
into the  Marshall  South  Lignite  Project  area,  SWEPCO has agreed to provide
guarantees of mine  reclamation in the amount of $85 million.  Since SWEPCO uses
self-bonding,  the guarantee  provides for SWEPCO to commit to use its resources
to complete the  reclamation in the event the work is not completed by the third
party  miner.  The  current  cost  to  reclaim  the  mine  is  estimated  to  be
approximately $36 million.

      Other Commitments and Contingencies

      CPL Nuclear Insurance
      In  connection  with the  licensing  and operation of STP, the owners have
purchased nuclear property and liability  insurance coverage as required by law,
and have executed indemnification agreements with the NRC in accordance with the
financial protection requirements of the Price-Anderson Act.

      The Price-Anderson Act, a comprehensive  statutory  arrangement  providing
limitations  on nuclear  liability and  governmental  indemnities,  is in effect
until August 1, 2002. The limit of liability  under the  Price-Anderson  Act for
licensees of nuclear power plants is $8.92 billion per incident, effective as of
December  1997.  The owners of STP are insured for their share of this liability
through a  combination  of private  insurance  amounting  to $200  million and a
mandatory  industry-wide program for self-insurance  totaling $8.72 billion. The
maximum  amount  that each  licensee  may be  assessed  under the  industry-wide
program of self-insurance following a nuclear incident at an insured facility is
$75.5  million per  reactor,  which may be adjusted for  inflation,  plus a five
percent charge for legal expenses, but not more than $10 million per reactor for
each nuclear  incident in any one year. CPL and each of the other STP owners are
subject to such  assessments,  which CPL and other  owners  have  agreed will be
allocated  on the basis of their  respective  ownership  interests  in STP.  For
purposes of these assessments, STP has two licensed reactors.

      The owners of STP currently maintain on-site decontamination liability and
property  damage  insurance in the amount of $2.75  billion  provided by ANI and
NEIL.  Policies  of  insurance  issued  by ANI and NEIL  stipulate  that  policy
proceeds  must be used first to pay  decontamination  and cleanup  costs  before
being used to cover direct losses to property. Under project agreements, CPL and
the other owners of STP will share the total cost of  decontamination  liability
and property  insurance for STP,  including  premiums and assessments,  on a pro
rata basis, according to each owner's respective ownership interest in STP.

      CPL purchased,  for its own account, a NEIL I Business Interruption and/or
Extra Expense  policy.  This  insurance  will  reimburse CPL for extra  expenses
incurred  for  replacement  generation  or  purchased  power as the  result of a
covered  accident that shuts down production at one or both of the STP Units for
more than 23 consecutive  weeks.  In the event of an outage of STP Units 1 and 2
and the outage is the result of the same accident, such insurance will reimburse
CPL up to 80% of the recovery.  The maximum amount recoverable for a single unit
outage is $118.6  million for both Unit 1 and 2. CPL is subject to an additional
assessment  up to $1.8  million  for the  current  policy year in the event that
insured losses at a nuclear facility covered under the NEIL I policy exceeds the
accumulated  funds  available  under the policy.  CPL renewed its current NEIL I
Business Interruption and/or Extra Expense policy September 15, 1997.

                                       49
<PAGE>

      For further information relating to litigation associated with CPL nuclear
insurance claims, reference is made to NOTE 2. LITIGATION AND REGULATORY
PROCEEDINGS.

      SWEPCO Cajun Asset Purchase Proposal
      Cajun filed a petition for  reorganization  under Chapter 11 of the United
States Bankruptcy Code on December 21, 1994 and is currently operating under the
supervision  of the United States  Bankruptcy  Court for the Middle  District of
Louisiana.

      On March 18, 1998,  SWEPCO,  together  with the Cajun  Members  Committee,
which  currently   represents  7  of  the  12  Louisiana   member   distribution
cooperatives  that are served by Cajun,  filed the SWEPCO Plan in the bankruptcy
court. Under the SWEPCO Plan, a SWEPCO affiliate or subsidiary would acquire all
of the  non-nuclear  assets  of Cajun,  comprised  of the  two-unit  Big Cajun I
natural  gas-fired  plant,  the  three-unit Big Cajun II coal-fired  plant,  and
related  non-nuclear  assets,  for $940.5 million in cash, subject to adjustment
pursuant to terms of the asset purchase agreement proposed as part of the SWEPCO
plan. The SWEPCO Plan  incorporates  the terms of a settlement  between the RUS,
Cajun Members  Committee,  Claiborne Electric  Cooperative,  Inc. and SWEPCO. In
addition,  the SWEPCO Plan provides for SWEPCO and the Cajun member cooperatives
to enter into  long-term  power supply  agreements  which will provide the Cajun
member cooperatives with rate plan options and market access provisions designed
to ensure the long-term competitiveness of the cooperatives.  Eight cooperatives
and CLECO,  successor  to Teche  Electric  Cooperative,  already  have agreed to
purchase  power from  SWEPCO if SWEPCO's  plan is  confirmed  by the  bankruptcy
court.

      Entergy Texas is no longer a co-plan  proponent  with SWEPCO and the Cajun
Members Committee,  as it had been under SWEPCO plans filed prior to the January
15,  1998 plan.  SWEPCO  continues  to work with  Entergy  Texas to resolve  its
objection to the plan. The SWEPCO Plan filed March 18, 1998 replaces plans filed
previously by SWEPCO on January 15, 1998,  October 26, 1996,  September 30, 1996
and April 19, 1996. Two competing  plans of  reorganization  for the non-nuclear
assets of Cajun have been filed with the bankruptcy  court,  each with different
purchase  prices,  rate paths and other  provisions.  Confirmation  hearings  in
Cajun's  bankruptcy case are now scheduled  through April 1998.  Consummation of
the SWEPCO Plan is conditioned  upon  confirmation by the bankruptcy  court, and
the  receipt by SWEPCO and CSW of all  requisite  state and  federal  regulatory
approvals in addition to their board approvals. If the SWEPCO Plan is confirmed,
the $940.5 million required to consummate the acquisition of Cajun's non-nuclear
assets is expected to be financed  through a combination of external  borrowings
and internally generated funds with approximately 70% of the external borrowings
funded with  non-recourse  debt.  There can be no assurance that the SWEPCO Plan
will be confirmed by the bankruptcy  court or, if it is confirmed,  that it will
be approved by federal and state regulators.

      SWEPCO Rental and Lease Commitments
      SWEPCO has entered  into various  financing  arrangements  primarily  with
respect to coal  transportation  and  related  equipment,  which are  treated as
operating leases for rate-making  purposes.  At December 31, 1997, leased assets
of $45.7 million, less accumulated  amortization of $39.0 million, were included
in Electric Utility Plant on the Consolidated Balance Sheets and at December 31,
1996, leased assets were $46.0 million,  less accumulated  amortization of $36.9
million.

      SWEPCO Biloxi, Mississippi MGP Site
      SWEPCO was notified by Mississippi Power in 1994 that it may be a PRP at a
MGP site in Biloxi,  Mississippi,  which was  formerly  owned and  operated by a
predecessor of SWEPCO.  Since then,  SWEPCO has worked with Mississippi Power on
both the  investigation of the extent of contamination on the site as well as on
the   subsequent   sampling  of  the  site.  The  sampling   results   indicated
contamination  at the property as well as the possibility of contamination of an
adjacent  property.  A risk  assessment  was submitted to the MDEQ, and the MDEQ
requested  that  a  future  residential   exposure  scenario  be  evaluated  for
comparison  with  commercial  and  industrial   exposure   scenarios.   However,
Mississippi  Power and  SWEPCO do not  believe  that  cleanup  to a  residential

                                       50
<PAGE>

scenario is appropriate since this site has been  industrial/commercial for more
than 100 years,  and  Mississippi  Power plans to  continue  this type of usage.
Mississippi  Power and SWEPCO also presented a report to the MDEQ  demonstrating
that the ground water on the site was not potable,  further  demonstrating  that
cleanup to residential standards is not necessary.

      The MDEQ has not agreed to a non-residential  future land use scenario and
has requested further testing.  Following the additional  testing and resolution
of   whether   cleanup   must   meet  a   residential   usage   scenario   or  a
commercial/industrial  scenario,  a feasibility  study will be conducted to more
definitively  evaluate  remedial  strategies for the property.  The  feasibility
study process will require public input prior to a final decision being made.

      At  the  present  time,  SWEPCO  has  not  had  any  further   substantive
discussions  with  MDEQ  regarding  the  ultimate   resolution  of  this  issue.
Therefore,  a final range of cleanup costs is not yet  determinable.  SWEPCO has
incurred  approximately  $200,000 to date for its portion of the cleanup of this
site, and based on its preliminary estimates,  anticipates that an additional $2
million  may be  incurred.  Accordingly,  SWEPCO has  accrued $2 million for the
cleanup of the site.

      SWEPCO Voda Petroleum Superfund Site
      In April  1996,  SWEPCO  received  correspondence  from the EPA  notifying
SWEPCO  that it is a PRP to a  cleanup  action  planned  for the Voda  Petroleum
Superfund  Site located in  Clarksville,  Texas.  SWEPCO is conducting a records
review  to  compile  documentation  relating  to  SWEPCO's  past use of the Voda
Petroleum site. The proposed cleanup of the site is estimated by the EPA to cost
approximately $2 million and to take approximately twelve months to complete. An
option for over 30 PRPs to conduct  the  cleanup in lieu of EPA  conducting  the
cleanup is under  consideration.  Any liability  associated with this project is
not expected to have a material adverse effect on CSW's results of operations or
financial condition.

      CSW Energy Loans and Commitments
      CSW Energy has agreed to provide  construction  financing and other credit
support up to $235 million for the 330 MW Phillips  Sweeny  project.  CSW Energy
obtained the funds for this project through CSW's short-term  borrowing program.
Construction  of this plant began in  September  1996 and  commenced  commercial
operations in February  1998. At December 31, 1997, CSW Energy had provided $163
million,  including  development,  construction  and  financing,  of  the  total
estimated $189 million in project costs.  CSW Energy expects to obtain permanent
project  financing in the second  quarter of 1998 at which time the project will
return a significant  portion of the investment  and the  short-term  borrowings
will be repaid.  In addition,  CSW has provided letters of credit and guarantees
on  behalf  of other  independent  power  projects  totaling  approximately  $27
million.

      CSW International Enertek Project
      In July 1996,  CSW  International  announced a joint  venture  with Alpek,
through a subsidiary, to build, own and operate a 109 MW, gas-fired cogeneration
project at Alpek's Petrocel industrial complex in Altamira,  Tamaulipas, Mexico.
CSW  International  and  Alpek  each  will have 50%  ownership  in the  project,
Enertek, which will cost approximately $75 million. CSW International has agreed
to provide construction  financing for the project of which $62 million had been
funded at December 31, 1997. The Enertek  project began  operations in the first
quarter of 1998.


4.    INCOME TAXES

      CSW files a  consolidated  United  States  federal  income  tax return and
participates  in a tax  sharing  agreement  with its  subsidiaries.  Income  tax
includes United States federal income taxes,  applicable  state income taxes and
SEEBOARD's United Kingdom  corporation taxes. Total income taxes differ from the
amounts computed by applying the United States federal statutory income tax rate
to income before taxes for a number of reasons which are presented in the INCOME

                                       51
<PAGE>

TAX RATE  RECONCILIATION  table  below.  Information  concerning  income  taxes,
including total income tax expense, the reconciliation between the United States
federal statutory tax rate and the effective tax rate and significant components
of deferred income taxes follow.

     INCOME TAX EXPENSE                 1997       1996       1995
                                    ------------------------------
                                                 (millions)
     Included in Operating Expenses
        and Taxes
      Current (1)                       $47        $118      $105
      Deferred (1)                      117         120         1
      Deferred ITC (2)                  (13)        (14)      (14)
                                     ---------  ---------  --------
                                        151         224        92
     Included in Other Income and
        Deductions
      Current                            --          (1)        2
      Deferred                           (6)        (39)       (4)
                                     ---------  ---------  --------
                                         (6)        (40)       (2)
     Income Taxes for Discontinued
        Operations
        (includes $72 resulting from     --          78        13
         the gain on the sale
         of Transok for 1996)
                                     ---------  ---------  --------
                                     ---------  ---------  --------
                                       $145        $262      $103
                                     ---------  ---------  --------

   (1)Approximately  $30  million,  $49 million and $7 million of CSW's  Current
      Income Tax Expense was  attributable to SEEBOARD U.S.A. and was recognized
      as  United  Kingdom  corporation  tax  expense  for  1997,  1996 and 1995,
      respectively.  In  addition,  approximately  $7 million and $19 million of
      CSW's  Deferred  Income Tax  Expense in 1997 and 1996,  respectively,  was
      attributed to SEEBOARD U.S.A.
   (2)ITC  deferred in prior years are  included in income over the lives of the
      related properties.

     INCOME TAX RATE RECONCILIATION     1997      1996     1995
                                       --------------------------
                                           ($ in millions)
     Income before taxes attributable to:
      Domestic operations                $327       $562    $506
     Foreign operations                   147        146      13
                                       -------  --------  -------
     Income before taxes                 $474       $708    $519

     Tax at U.S. statutory rate          $166       $248    $182
     Differences
      Amortization of ITC                 (13)       (14)    (14)
      Mirror CWIP                           5          5     (11)
      Non-deductible goodwill              
       amortization                        12         13      --
      Tax credit on foreign              
       operations dividend                 (3)       (18)     --
     United Kingdom deferred         
       income tax adjustment              (16)        --      --
     CPL 1995 Agreement                    --         --     (34)
     WTU 1995 Stipulation and          
       Agreement                           --         --      (7)
     Adjustments                           (4)        10     (22)
     Other                                 (2)        18       9
                                       -------   -------  -------
                                         $145       $262    $103
                                       -------   -------  -------
    Effective tax rate                     31%        37%     20%


                                       52
<PAGE>

      DEFERRED INCOME TAXES (1)             1997       1996
                                          --------------------
                                              (millions)
      Deferred Income Tax Liabilities
        Depreciable utility plant           $1,920     $1,867
        Deferred plant costs                   176        178
        Mirror CWIP asset                      100        105
        Income tax related regulatory          
          assets                               211        207
        Other                                  371        307
                                          ---------  ---------
                                             2,778      2,664
      Deferred Income Tax Assets
        Income tax related regulatory         (123)      (126)
          liability
      Unamortized ITC                         (100)      (105)
      Alternative minimum tax carryforward     (27)       (83)
      Other                                    (76)       (99)
                                          ---------  ---------
                                              (326)      (413)

                                          ---------  ---------
      Net Accumulated Deferred Income       $2,452     $2,251
        Taxes
                                          ---------  ---------

      Net Accumulated Deferred Income
        Taxes
         Noncurrent                         $2,432     $2,272
         Current                                20        (21)
                                          ---------  ---------
                                            $2,452     $2,251
                                          ---------  ---------

     (1)In 1996,  CSW  generated  $33  million  of excess  foreign  tax  credits
        against which a full valuation  allowance was established as of December
        31, 1996. In 1997, the valuation  reserve was reduced to $17 million due
        to lower levels of excess foreign tax credits. Other than excess foreign
        tax  credits,  CSW did not  have  other  valuation  allowances  recorded
        against other deferred tax assets at December 31, 1997 and 1996 due to a
        favorable earnings history.


5.    BENEFIT PLANS

      Pension Plans
      Prior to June 30, 1997, CSW  maintained a tax qualified,  non-contributory
defined  benefit  pension plan covering  substantially  all CSW employees in the
United States.  Benefits were based on employees' years of credited service, age
at  retirement,  and  final  average  annual  earnings  with an  offset  for the
participant's  primary  Social  Security  benefit.  The CSW  board of  directors
approved an amendment, effective July 1, 1997, which converted the present value
of accrued  benefits under the existing pension plan into a cash balance pension
plan.  Under the cash balance  formula,  each  participant  has an account,  for
recordkeeping  purposes only, to which credits are allocated annually based on a
percentage of the participant's pay. The applicable  percentage is determined by
age and years of vested service the  participant  has with CSW as of December 31
of each year.

      The purpose of the plan change is to continue to provide retirement income
benefits which are competitive  both within the utility industry as well as with
other companies within the United States.

      As the plan sponsor, CSW will continue to reflect the costs of the pension
plan  according to the provisions of SFAS No. 87 and allocate such costs to each
of the participating  employers. As a result of the July 1, 1997 amendment,  CSW
realized a savings in 1997 of  approximately  $20 million in pension expense and
will also realize  significant  ongoing  reductions in operating and maintenance
expense  because of the  change.  The  change to the  pension  plan was  applied
retroactively to the beginning of 1997, so these savings were recognized  evenly
throughout 1997 with a portion being capitalized.

      Pension plan assets consist  primarily of common stocks and short-term and
intermediate-term fixed income investments.

                                       53
<PAGE>

      The  majority  of  SEEBOARD's  employees  joined a  pension  plan  that is
administered for the United Kingdom's electricity  industry.  The assets of this
plan are held in a separate trustee-administered fund that is actuarially valued
every three years.  SEEBOARD and its participating  employees both contribute to
the plan.  Subsequent  to July 1, 1995,  new  employees  were no longer  able to
participate in that plan. Instead,  two new pension plans were made available to
new employees, both of which are also separate trustee-administered plans.

      Information  about the two separate  pension  plans (the U.S. plan and the
non-U.S.   plan),   including:   (i)  pension  plan  net   periodic   costs  and
contributions;  (ii) pension plan  participation;  (iii) a reconciliation of the
funded  status of the  pension  plan to the  amounts  recognized  on the balance
sheets; and (iv) assumptions used in accounting for the pension plan follow.

NET PERIODIC PENSION                   1997                      1996     1995
PLAN COSTS AND           1997   1997   NON-     1996    1996     NON-     U.S.
CONTRIBUTIONS             CSW   U.S.   U.S.     CSW     U.S.     U.S.     PLAN
                         PLANS  PLAN   PLAN    PLANS    PLAN     PLAN     ONLY
                         -------------------------------------------------------
                                                 (millions)
Net Periodic Pension
  Costs
    Service cost           $34    $20   $14     $37     $23      $14       $20
    Interest cost on
     projected benefit    
     obligation            137     65    72     136      69       67        64
    Actual return on     
     plan assets          (245)  (163)  (82)   (184)   (110)     (74)     (117)
    Net amortization        
     and deferral           68     66     2      27      27       --        44
                         --------------------- -------------------------  ------
                           $(6)  $(12)   $6     $16      $9       $7       $11
                         --------------------- -------------------------  ------

Pension Plan Contributions  $6    $--    $6     $35     $28       $7       $29


               APPROXIMATE NUMBER                       NON-
               OF PARTICIPANTS IN       CSW     U.S.    U.S.
               PLANS DURING 1997       PLANS    PLAN    PLAN
                                     -------------------------

               Active employees        10,100   7,200   2,900
               Retirees                10,200   4,200   6,000
               Terminated employees     6,800   2,000   4,800


RECONCILIATION OF FUNDED                       1997                        1996
STATUS OF PLAN TO AMOUNTS      1997    1997    NON-       1996     1996    NON-
RECOGNIZED ON THE CSW          CSW     U.S.    U.S.        CSW     U.S.    U.S.
CONSOLIDATED BALANCE SHEETS   PLANS    PLAN    PLAN       PLANS    PLAN    PLAN
                              --------------------------------------------------
                                                  (millions)
Actuarial present value of
 Accumulated benefit
  obligation for service        
  rendered to date             $1,860   $896    $964     $1,748     $781   $967
 Additional benefit for
  future salary levels             94     35      59        200      141     59
                                -----------------------  -----------------------
  Projected benefit obligation  1,954    931   1,023      1,948      922  1,026
Plan assets, at fair value      2,290  1,109   1,181      2,077      991  1,086
                              -------------------------  -----------------------
Plan assets in excess of the
  projected benefit obligation    336    178     158        129       69     60
Unrecognized net loss            (86)    12     (98)         30       27      3
Unrecognized prior service cost  (93)   (88)     (5)        (12)      (7)    (5)
Unrecognized net obligation       16     11       4          16       12      4
                              -------------------------  -----------------------
       Prepaid pension cost     $173   $113     $59        $163     $101    $62
                              -------------------------  -----------------------

      The vested portion of the accumulated benefit obligations for the combined
plans was $1.8  billion at December  31, 1997 and $1.7  billion for the combined
plans at December 31, 1996. The unrecognized net obligation for the U.S. plan is

                                       54
<PAGE>

being  amortized  over the average  remaining  service  life of  employees or 15
years.  Prepaid pension cost is included in Deferred Charges and Other Assets on
the balance sheets.

      In  addition  to  the  amounts  shown  in  the  above  table,  CSW  has  a
non-qualified  excess  benefit plan.  This plan is available to all pension plan
participants  who are entitled to receive a pension benefit from CSW which is in
excess of the  limitations  imposed on benefits  by the  Internal  Revenue  Code
through the qualified plan. CSW's net periodic cost for this  non-qualified plan
for the years ended  December 31,  1997,  1996 and 1995 was $3.7  million,  $4.8
million and $2.4 million, respectively.

     ASSUMPTIONS USED IN                          Long-Term
     ACCOUNTING FOR THE                           Compensation 
     PENSION PLAN                                 Plan         Return on
                                    Discount Rate Increase     Assets
                                    ------------------------------------

     1997  U.S. Plan                  7.50%        5.46%        9.00%
           Non-U.S. Plan              6.75%        4.75%        7.25%
     1996  U.S. Plan                  8.00%        5.46%        9.50%
           Non-U.S. Plan              7.75%        5.75%        8.25%
     1995  U.S. Plan                  8.00%        5.46%        9.50%

      Postretirement Benefits Other Than Pensions (U.S. Companies Only)
      CSW, including each of the U.S. Electric Operating Companies, adopted SFAS
No. 106 effective  January 1, 1993.  The  transition  obligation  established at
adoption is being  amortized  over twenty years,  with fifteen years  remaining.
Prior to 1993,  these  benefits  were  accounted for on a  pay-as-you-go  basis.
Pursuant to an order by the Oklahoma  Commission,  PSO  established a regulatory
asset of  approximately  $5  million  in 1993  for the  difference  between  the
pay-as-you-go  basis  and the  costs  determined  under  SFAS  No.  106.  PSO is
recovering the amortization of this regulatory asset over a ten year period.

      Information about the non-pension  postretirement benefit plan, including:
(i) net periodic  postretirement  benefit costs;  (ii) a  reconciliation  of the
funded status of the  postretirement  benefit plan to the amounts  recognized on
the  balance  sheets;   and  (iii)   assumptions  used  in  accounting  for  the
postretirement benefit plan follow.

     NET PERIODIC POSTRETIREMENT 
     BENEFIT COSTS              1997       1996      1995
                             ------------------------------
                                        (millions)

      Service cost              $ 8         $8        $8
      Interest cost on APBO      18         19        18
      Actual  return on plan    
       assets                   (22)        (7)       (8)
      Amortization of     
       transition obligation      9          9         9
      Net amortization and     
       deferral                  11         (2)        2
                             --------   --------  ---------
                                $24        $27       $29
                             --------   --------  ---------

                                       55
<PAGE>

     RECONCILIATION OF FUNDED
     STATUS OF PLAN TO  AMOUNTS
     RECOGNIZED ON THE BALANCE SHEETS        1997       1996
                                          -------------------
                                               (millions)
     APBO
      Retirees                               $158       $163
      Other fully eligible participants        24         18
      Other active participants                59         55
                                          --------   --------
      Total                                   241        236
     Plan assets at fair value               (159)      (123)
                                          --------   --------
     APBO in excess of plan assets             82        113
     Unrecognized transition obligation      (135)      (144)
     Unrecognized gain                         53         32
                                          --------   --------
        Accrued Cost                          $--         $1
                                          --------   --------

     ASSUMPTIONS USED IN THE                    Return on   Tax Rate
     ACCOUNTING FOR SFAS NO. 106     Discount   Plan        for
                                     Rate       Assets      Taxable Trusts
                                     -------------------------------------
     1997                             7.50%      9.00%       39.6%
     1996                             8.00%      9.50%       39.6%
     1995                             8.00%      9.50%       39.6%

            Health care cost trend rates
               1997  Average  Rate of 7.0%  grading  down  .50%  per  year to an
                  ultimate average rate of 5.00% in 2001.
               1996  Average  Rate of 9.0%  grading  down  .75%  per  year to an
                  ultimate average rate of 5.25% in 2001.
               1995  Average  Rate of  10.25%  grading  down .75% per year to an
                  ultimate average rate of 5.75% in 2001.

      Increasing  the assumed  health  care cost trend  rates by one  percentage
point in each year would  increase the APBO by  approximately  $25.2 million and
the aggregate of the service and interest costs components on net postretirement
benefits by approximately $3.6 million.

      Health and Welfare Plans
      CSW  provides  medical,  dental,  group  life  insurance,  dependent  life
insurance,   and  accidental  death  and   dismemberment   insurance  plans  for
substantially  all active CSW System  employees in the United States.  The total
contributions,  recorded on a pay-as-you-go  basis, for the years ended December
31, 1997,  1996, and 1995 were $35.6  million,  $28.4 million and $27.0 million,
respectively.  Employer  provided  health  care  benefits  are not common in the
United Kingdom due to the country's  national  health care system.  Accordingly,
SEEBOARD does not provide health care benefits to the majority of its employees.


6.    JOINTLY OWNED ELECTRIC UTILITY PLANT

      The U.S.  Electric  Operating  Companies  are  parties  to  various  joint
ownership agreements with other non-affiliated entities. Such agreements provide
for the joint  ownership  and  operation  of  generating  stations  and  related
facilities,  whereby each  participant  bears its share of the project costs. At
December 31, 1997, the U.S. Electric Operating Companies had undivided interests
in five  such  generating  stations  and  related  facilities  as  shown  in the
following table.

                       CPL       SWEPCO      SWEPCO      SWEPCO       CSW(1)
                       STP     Flint Creek   Pirkey    Dolet Hills  Oklaunion
                     Nuclear      Coal       Lignite     Lignite       Coal
                      Plant      Plant       Plant       Plant        Plant
                   ----------------------------------------------------------
                                        ($ in millions)

Plant in service     $2,336        $80        $437        $230         $398
Accumulated            $517        $47        $176         $84         $122
depreciation
Plant capacity-MW     2,501        528         675         650          676
Participation         25.2%      50.0%       85.9%       40.2%        78.1%
Share of capacity-MW    630        264         580         262          528

                                       56
<PAGE>
7.    FINANCIAL INSTRUMENTS

      The following  methods and assumptions were used to estimate the following
fair values of each class of financial  instruments  for which it is practicable
to estimate  fair value.  The fair value does not affect any of the  liabilities
unless the issues are redeemed prior to their maturity dates.

      Cash,  temporary cash investments,  accounts  receivable,  other financial
      instruments  and short-term debt The fair value equals the carrying amount
      as stated on the balance sheets
due to the short maturity of those instruments.

      Securities held for sale
      The fair  values,  which  are  based on quoted  market  prices,  equal the
carrying amounts as stated on the balance sheet because the accounting treatment
prescribed under SFAS No. 115.

      Long-term debt
      The fair value of long-term  debt is estimated  based on the quoted market
prices for the same or similar issues or on the current rates offered to CSW for
debt of the same remaining maturities.

      Trust Preferred Securities
      The fair  value of the  Trust  Preferred  Securities  are  based on quoted
market prices on the New York Stock Exchange.

      Preferred stock subject to mandatory redemption
      The fair value of  preferred  stock  subject to  mandatory  redemption  is
estimated based on quoted market prices for the same or similar issues or on the
current  rates  offered  to CSW for  preferred  stock  with the same or  similar
remaining redemption provisions.

      Long-term debt and preferred  stock due within 12 months The fair value of
      current maturities of long-term debt and preferred stock
due within 12 months are estimated based on quoted market prices for the same or
similar  issues or on the current rates offered for long-term  debt or preferred
stock with the same or similar remaining redemption provisions.

CARRYING VALUE AND ESTIMATED FAIR VALUE          1997     1996
                                              -------------------
                                                  (millions)
Long-term debt
   Carrying amount                             $3,898    $4,024
   Fair value                                   4,052     4,065

Trust Preferred Securities
   Carrying amount                                335        --
   Fair value                                     344        --

Preferred stock subject to mandatory redemption
   Carrying amount                                 26        33
   Fair value                                      27        34

Long-term debt and preferred stock
  due within 12 months
   Carrying amount                                 32       204
   Fair value                                      32       204

                                       57
<PAGE>
      Cross-currency swaps and SEEBOARD's  electricity contracts for differences
      The fair value of cross currency swaps reflect third-party valuations
calculated using proprietary  pricing models.  Based on these valuations,  CSW's
position in these cross  currency swaps  represented  an unrealized  loss of $43
million at December 31, 1997. This unrealized loss is offset by unrealized gains
related to the underlying  transactions  being hedged. CSW expects to hold these
contracts to maturity. The fair value of SEEBOARD's contracts for differences is
not determinable due to the absence of a trading market.

DERIVATIVE CONTRACTS NOTIONAL AMOUNTS    Notional        Fair
AND ESTIMATED FAIR VALUES                 Amount        Value
                                        ----------------------
                                               (millions)
CROSS CURRENCY SWAPS
   Maturities: 2001 and 2006               $400          $443


8.    LONG-TERM DEBT

      The CSW System's  long-term debt outstanding as of the end of the last two
years is presented in the following table.

  Maturities                 Interest Rates           December 31,
From       To                From       To        1997            1996
----------------------------------------------------------------------
                                                       (millions)
Secured bonds
1998      2025               5.25%     7.75%     $2,080         $2,108

Unsecured bonds
2001      2030                3.9%(1)  8.88%      1,353          1,384

Notes and Lease Obligations
1999      2003               5.54%     9.75%        641            724

Unamortized discount                                (10)           (12)
Unamortized cost of
  reacquired debt                                  (166)          (180)
                                                 ---------------------
                                                 $3,898         $4,024
                                                 ---------------------
(1)  Variable rate

      The mortgage indentures, as amended and supplemented, securing FMBs issued
by the U.S.  Electric  Operating  Companies,  constitute a direct first mortgage
lien on substantially  all electric utility plant. The U.S.  Electric  Operating
Companies may offer  additional  FMBs,  medium-term  notes and other  securities
subject to market conditions and other factors.

      CSW's  year  end  weighted  average  cost of  long-term  debt was 7.2% for
1995-1997.

      Annual Requirements
      Certain series of outstanding FMBs have annual sinking fund  requirements,
which  are  generally  1% of the  amount  of  each  such  series  issued.  These
requirements  may be, and generally have been,  satisfied by the  application of
net  expenditures  for  bondable  property in an amount equal to 166-2/3% of the
annual requirements. Certain series of pollution control revenue bonds also have
sinking  fund  requirements.  At December  31,  1997,  the annual  sinking  fund
requirements and annual maturities (including sinking fund requirements) for all
long-term debt for the next five years are presented in the following table.

                                       58
<PAGE>
               Sinking Fund    Annual
               Requirements  Maturities
              ------------- ------------
                     (millions)

1998               $1           $31
1999                1           195
2000                1           208
2001                1           517
2002                1           181

      Dividends
      At December  31,  1997,  approximately  $1.4  billion of CSW's  subsidiary
companies'  retained  earnings were  available for payment of cash  dividends by
such subsidiaries to CSW. The mortgage indentures,  as amended and supplemented,
at CPL  and PSO  contain  certain  restrictions  on the  use of  their  retained
earnings for cash  dividends on their common stock.  These  restrictions  do not
currently limit the ability of CSW to pay dividends to its shareholders.

      Reacquired Long-term Debt
      During 1996 and 1995, the U.S.  Electric  Operating  Companies  reacquired
$205  million  and $355  million  of  long-term  debt,  respectively,  including
reacquisition   premiums,   prior  to   maturity.   The   premiums  and  related
reacquisition  costs and discounts are included in long-term debt on the balance
sheets and are being  amortized  over  periods  consistent  with their  expected
ratemaking  treatment.  The remaining  amortization periods for such items range
from 2 to 33 years.  No long-term debt was reacquired  prior to maturity  during
1997.

      Reference is made to MD&A,  LIQUIDITY  AND CAPITAL  RESOURCES  for further
information  related to long-term debt,  including new issues and reacquisitions
of long-term debt during 1997 as well as information related to the financing of
the SEEBOARD acquisition.


9.    PREFERRED STOCK

      The outstanding  preferred stock of the U.S. Electric Operating  Companies
as of the end of the last two years is presented in the following table.

                                                               Current
                            Dividend Rate   December 31,   Redemption Price
                              From - To     1997    1996      From - To
                           --------------------------------------------------
                                             (millions)
Not subject to mandatory redemption
  1,352,900 shares           4.00% - 8.72%   $19    $135   $102.75 - $109.00
  1,600,000 shares              auction      160     160        $100.00
Issuance expenses/premiums                    (3)     (3)
                                            ------------
                                            $176    $292
                                            ------------
Subject to mandatory redemption
  340,000 shares                 6.95%       $27     $34        $102.32
  To be redeemed within one year              (1)     (1)
                                            ------------
                                             $26     $33
                                            ------------
Total authorized shares
     6,405,000

      All of the outstanding  preferred stock is redeemable at the option of the
U.S. Electric Operating  Companies upon 30 days notice at the current redemption
price per share.  During  1997,  1996 and 1995,  SWEPCO  redeemed  $1.2  million
annually  pursuant to its annual sinking fund  requirement.  In addition  during
1997, each of the U.S.  Electric  Operating  Companies  reacquired a significant
portion of its outstanding  preferred stock. As a result of differences  between
the dividend rates on the reacquired securities and prevailing market rates, CSW
realized an overall gain of approximately $10 million on the transactions.  This

                                       59
<PAGE>
gain is  shown  separately,  as  Gain  on  reacquired  preferred  stock,  on the
Consolidated  Statements of Income. The following table shows the results of the
tender offers of the U.S. Electric Operating Companies' preferred stock.

                                Shares           Shares
                              Reacquired       Remaining
                              --------------------------
   CPL
   Series 4.00%                 57,952           42,048
   Series 4.20%                 57,524           17,476
   Series 7.12%                260,000               --
   Series 8.72%                500,000               --

   PSO
   Series 4.00%                 53,260           44,640
   Series 4.24%                 91,931            8,069

   SWEPCO
   Series 4.28%                 52,614            7,386
   Series 4.65%                 23,092            1,908
   Series 5.00%                 37,261           37,739
   Series 6.95%                 65,990          274,010

   WTU
   Series 4.40%                 36,325           23,675

      The  dividends  on CPL's $160 million  auction and money market  preferred
stocks are adjusted every 49 days,  based on current market rates.  The dividend
rates averaged 4.3%, 4.1% and 4.5% during 1997, 1996 and 1995, respectively. The
minimum annual sinking fund requirement for SWEPCO's  preferred stock subject to
mandatory  redemption  is $1.2  million for the years 1997  through  2001.  This
sinking fund retires 12,000 shares annually.


10.   TRUST PREFERRED SECURITIES

       The  following  Trust  Preferred  Securities  issued by the  wholly-owned
statutory  business  trusts of CPL, PSO and SWEPCO were  outstanding at December
31,   1997.   They   are   classified   on  the   balance   sheet   as   Certain
Subsidiary-obligated,  mandatorily redeemable preferred securities of subsidiary
trusts holding solely Junior Subordinated Debentures of such Subsidiaries.

                                           Amount    Description of Underlying
Business Trust    Security         Units (millions)  Debentures of Registrant
------------------------------------------------------------------------------

CPL Capital I   8.00%, Series A   6,000,000  $150    CPL, $154.6 million, 8.00%,
                                                      Series A
PSO Capital I   8.00%, Series A   3,000,000    75    PSO, $77.3 million, 8.00%,
                                                      Series A
SWEPCO CapitalI 7.875%, Series A  4,400,000   110    SWEPCO, $113.4 million, 
                                                      7.875%, Series A
                                 ---------- -----
                                 13,400,000  $335
                                 ---------- -----

      Each of the business  trusts will be treated as a subsidiary of its parent
company. The only assets of the business trusts are the subordinated  debentures
issued  by  their  parent  company  as  specified  above.  In  addition  to  the
obligations under their  subordinated  debentures,  each of the parent companies
has  also  agreed  to  a  security   obligation  which  represents  a  full  and
unconditional guarantee of its capital trust's obligation.


11.   SHORT-TERM FINANCING

      The CSW System uses short-term debt,  primarily  commercial paper, to meet
fluctuations  in working capital  requirements  and other interim capital needs.
CSW has established a money pool to coordinate short-term borrowings for certain

                                       60
<PAGE>
subsidiaries  and also  incurs  borrowings  outside  the  money  pool for  other
subsidiaries.  As of December  31, 1997,  CSW had  revolving  credit  facilities
totaling $1.4 billion to back up its commercial  paper program.  At December 31,
1997,  CSW had $721 million  outstanding in short-term  borrowings.  The maximum
amount of such short-term  borrowings  outstanding  during the year, which had a
weighted  average  interest  yield for the year of 5.8%, was $725 million during
December 1997.

      CSW  Credit,  which  does  not  participate  in  the  money  pool,  issues
commercial paper on a stand-alone  basis. At December 31, 1997, CSW Credit had a
$900 million revolving credit agreement that is secured by the assignment of its
receivables  to back up its  commercial  paper  program  which had $637  million
outstanding.  The maximum amount of such commercial paper outstanding during the
year, which had a weighted average interest yield for the year of 5.6%, was $890
million during September 1997.


12.   COMMON STOCK

      CSW  adopted  SFAS  No.  128  during  1997.  SFAS  No.  128  requires  the
computation  of earnings  per share on both a basic as well as a diluted  basis.
CSW's basic  earnings  per share of common  stock are  computed by dividing  net
income for common stock by the average number of common shares  outstanding  for
the  respective  periods.  Diluted  earnings  per share  reflect  the  potential
dilution that could occur if all options outstanding under CSW's stock incentive
plan were  converted  to common  stock and then  shared in the income for common
stock.  CSW's basic and diluted  earnings  per share were the same for the years
1995 - 1997. CSW's dividends per common share reflect per share amounts paid for
each of the periods.

      CSW can issue common stock,  either through the purchase and reissuance of
shares from the open market or original issue shares,  through the LTIP, a stock
option plan,  PowerShare and ThriftPlus.  Following the issuance of the CPL 1997
Original  Rate Order and the decline in the market price of CSW's common  stock,
which CSW believes is  attributable in part to the CPL 1997 Original Rate Order,
the  determination  was made that it was  appropriate  for CSW to begin  funding
these plans through open market  purchases,  effective  April 1, 1997.  Prior to
that time,  CSW had issued $20 million in new common stock in 1997.  Information
concerning common stock activity issued through the LTIP, the stock option plan,
PowerShare and ThriftPlus is presented in the following table.

                               1997               1996               1995
                         -------------------------------------------------------
Number of new shares
   issued (millions)            0.8                2.9                2.3
Range of stock price for
   new shares            $21 1/4 - $25 5/8  $24 3/8 - $28 7/8  $22 5/8 - $28 3/8
New common stock 
   equity (millions)            $20                $79                $57

      During  February  1996,  CSW sold  15,525,000  shares  of CSW  Common in a
primary stock offering and received net proceeds of approximately  $398 million.
These proceeds were used to repay a portion of indebtedness  incurred during the
acquisition of SEEBOARD.


13.   STOCK-BASED COMPENSATION PLANS

      CSW has a key employee  incentive  plan.  This plan is accounted for under
Accounting Principles Board Opinion No. 25, under which no compensation cost has
been recognized.  Had compensation cost for this plan been determined consistent
with SFAS No. 123, pro forma  calculations  of CSW's net income for common stock
and  earnings  per share as  required  by SFAS No.  123  would not have  changed
significantly from amounts reported.

                                       61
<PAGE>
      Because  the SFAS No. 123  method of  accounting  has not been  applied to
options  granted prior to January 1, 1995, the resulting pro forma  compensation
cost may not be representative of that to be expected in future years.

      CSW may grant options for up to 4.0 million shares of CSW Common under the
stock option plan. Under the stock option plan, the option exercise price equals
the stock's market price on the date of grant. The grant vests over three years,
one-third on each of the three  anniversary  dates of the grant,  and expires 10
years after the original  grant date. CSW has granted 2.8 million shares through
December 31, 1997.

      A summary of the status of CSW's stock  option plan at December  31, 1997,
1996 and 1995 and the changes  during the years then ended is  presented  in the
following table.

<TABLE>
<CAPTION>
                               1997                  1996                 1995
                     -----------------------------------------------------------------------
                                 Weighted               Weighted                Weighted
                      Shares      Average    Shares     Average    Shares        Average
                    (thousands)  Exercise  (thousands)  Exercise (thousands)  Exercise Price
                                   Price                 Price
<S>                   <C>          <C>        <C>        <C>       <C>             <C>
Outstanding at
  beginning of year    1,412        $26        1,564      $26       1,616           $26
Granted                  694         21           70       27          --            --
Exercised                 --         22         (147)      24        (23)            22
Canceled                (204)        28          (75)      27        (29)            27
                      ------                   -----                ----
Outstanding at end of
   year                1,902         24        1,412       26       1,564            26

Exercisable at end of
  year                 1,162        n/a        1,004      n/a         828           n/a

Weighted average fair
   value of options    $2.24 - $2.39
</TABLE>

      The fair  value of each  option  grant is  estimated  on the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions  used for grants in 1997: (i) risk-free  interest rate of 5.9%; (ii)
expected  dividend  rate of 6.5%;  (iii) and  expected  volatility  of 19%.  The
expected  life of the  options  granted  did not  materially  impact  the values
produced.


14.   BUSINESS SEGMENTS

      CSW's  business  segments at December 31, 1997 included the U.S.  Electric
operations  (CPL, PSO, SWEPCO,  WTU) and the United Kingdom Electric  operations
(SEEBOARD U.S.A.). See NOTE 1. SUMMARY OF SIGNIFICANT  ACCOUNTING POLICIES for a
discussion of the  accounting  for the SEEBOARD  acquisition.  Eight  additional
non-utility  companies are included  with CSW in Corporate  items and Other (CSW
Energy, CSW  International,  C3  Communications,  CSW Credit,  CSW Leasing,  CSW
Services,  EnerShop and CSW Energy Services). Gas Operations (Transok) were sold
on June 6, 1996.  See NOTE 15.  TRANSOK  DISCONTINUED  OPERATIONS for additional
information.  CSW's business  segment  information is presented in the following
tables.

                                       62
<PAGE>
                                    1997        1996        1995
                                  --------    --------    --------
                                                   (millions)
OPERATING REVENUES
  Electric Operations
     United States                  $3,321      $3,248      $2,883
     United Kingdom (1)              1,870       1,848         208
  Corporate items and Other             77          59          52
                                  --------    --------    --------
                                    $5,268      $5,155      $3,143
                                  --------    --------    --------
OPERATING INCOME
  Electric Operations
     United States                    $661        $768        $719
     United Kingdom (1)                255         236          21
  Corporate items and Other            (30)         15         (27)
                                  --------    --------    --------
  Operating income before taxes        886       1,019         713
  Income taxes                        (151)       (224)        (92)
                                  --------    --------    --------
                                      $735        $795        $621
                                  --------    --------    --------
DEPRECIATION AND AMORTIZATION
  Electric Operations
    United States                     $389        $362        $335
    United Kingdom (1)                  92          88           7
  Corporate items and Other             16          14          11
                                  --------    --------    --------
                                      $497        $464        $353
                                  --------    --------    --------
IDENTIFIABLE ASSETS
  Electric Operations
     United States                  $9,172      $9,142      $9,278
     United Kingdom (1)              2,931       3,061       2,821
  Corporate items and Other          1,348       1,129       1,004
                                  --------    --------    --------
                                    13,451      13,332      13,103
  Gas Operations (Discontinued)       --          --           766
                                  --------    --------    --------
                                   $13,451     $13,332     $13,869
                                  --------    --------    --------
CAPITAL EXPENDITURES AND
ACQUISITIONS
  Electric Operations
     United States                    $346        $356        $398
     United Kingdom (1), (2)           126       1,543         731
  Corporate items and Other (3)        276         109          19
                                  --------    --------    --------
                                       748       2,008       1,148
  Gas Operations (Discontinued)       --            23          66
                                  --------    --------    --------
                                      $748      $2,031      $1,214
                                  --------    --------    --------

(1)  Represents equity method of accounting for November 1995 (27.6%) and full
     consolidation accounting for December 1995 (76.45%).
(2)  Includes $1,394 million and $731 million in 1996 and 1995, respectively, 
     used to purchase SEEBOARD.
(3) Includes CSW Energy and CSW International equity investments.


                                       63
<PAGE>


15.   TRANSOK DISCONTINUED OPERATIONS

      On June 6, 1996,  CSW sold Transok to Tejas.  Accordingly,  the results of
operations for Transok have been reported as  discontinued  operations and prior
periods have been restated for consistency.

      As a wholly owned  subsidiary  of CSW,  Transok  operated as an intrastate
natural gas  gathering,  transmission,  marketing  and  processing  company that
provided  natural  gas  services  to  the  U.S.  Electric  Operating  Companies,
predominantly PSO, and to other gas customers throughout the United States.

      CSW sold Transok to Tejas for  approximately  $890 million,  consisting of
$690 million in cash and $200 million in existing  long-term  debt that remained
with Transok  after the sale.  A portion of the cash  proceeds was used to repay
borrowings  incurred  related  to the  SEEBOARD  acquisition  and the  remaining
proceeds were used to repay commercial paper  borrowings.  CSW recorded an after
tax gain on the sale of Transok of approximately $120 million in 1996.

      Transok's  operating  results  for 1996 and  1995  are  summarized  in the
following table (transactions with CSW have not been eliminated).

                                           1996           1995
                                           -------------------


Total revenue                              $362           $721

Operating income before income taxes         23             52

Earnings before income taxes                 18             38
Income taxes                                 (6)           (13)
                                           -------------------
Net income from discontinued operations     $12            $25
                                           -------------------


16.   PROPOSED AEP MERGER

      In December 1997, CSW and AEP entered into a definitive  merger  agreement
for a  tax-free,  stock-for  stock  transaction  with AEP  being  the  surviving
corporation.  The  transaction  is subject to the approval of various  state and
federal  regulatory  agencies.  The shareholders of CSW will be asked to approve
the AEP Merger and the shareholders of AEP will be asked to approve the issuance
of shares of AEP common stock pursuant to the AEP Merger  Agreement and to amend
AEP's  certificate of incorporation to increase the number of authorized  shares
of AEP common stock from 300 million shares to 600 million shares.

      The proposed AEP Merger, with a targeted completion date in the first half
of 1999, is expected to be accounted for as a pooling of interests.

            Upon  completion  of the AEP Merger,  CSW common  stockholders  will
receive 0.6 shares of AEP common  stock for each share of CSW common  stock.  At
that time, CSW common stockholders will own approximately 40% of the outstanding
common stock of AEP.  Under the AEP Merger  Agreement,  there will be no changes
required  with  respect  to the  outstanding  debt,  preferred  stock  or  Trust
Preferred  Securities of CSW or its  subsidiaries.  The transaction must satisfy
many conditions, some of which may not be waived by the parties. There can be no
assurance that the AEP Merger will be consummated.


17.   EXTRAORDINARY ITEM

      In the general  election  held in the United  Kingdom on May 1, 1997,  the
United  Kingdom's Labour Party won control of the government with a considerable
majority. Prior to the general election, the Labour Party had announced that, if
elected,  it would impose a windfall  profits tax on certain  industries  in the
United Kingdom,  including the privatized utilities, to fund a variety of social

                                       64
<PAGE>
improvement  programs.  On July 2, 1997, the one-time  windfall  profits tax was
introduced in the Labour  Party's  Budget and the  legislation  enacting the tax
subsequently  was passed during the third quarter of 1997.  Accordingly,  during
the third quarter of 1997,  SEEBOARD U.S.A.  accrued,  as an extraordinary item,
(pound)109.5 million (or $176 million when converted at (pound)1.00=$1.61) for a
one-time, windfall profits tax enacted by the United Kingdom government.

      The  windfall  profits  tax is  payable  in two  equal  installments,  due
December 1, 1997 and  December 1, 1998.  The tax was charged at a rate of 23% on
the  difference  between nine times the average  profits  after tax for the four
years  following  flotation  in  1990,  and  SEEBOARD's  market   capitalization
calculated  as the  number  of  shares  issued at  flotation  multiplied  by the
flotation  price per share.  On December 1, 1997,  SEEBOARD  made the first such
payment.

      As enacted,  the  windfall  profits tax is not tax  deductible  for United
Kingdom  purposes.  To date,  no  United  States  income  tax  benefit  has been
recognized  due to the  uncertainty  as to the impact on the use of foreign  tax
credits. CSW continues to analyze the potential United States income tax benefit
from the use of foreign tax credits.


18.   PRO FORMA INFORMATION (UNAUDITED)

      CSW secured  effective control of SEEBOARD in December 1995. The unaudited
pro forma  information is presented in response to applicable  accounting  rules
relating to acquisition transactions.  The pro forma information gives effect to
the  acquisition  of  SEEBOARD  accounted  for  under  the  purchase  method  of
accounting for the twelve months ended  December 31, 1995 as if the  transaction
had been consummated at the beginning of the period presented.

      The unaudited pro forma  information  has been prepared in accordance with
United  States  generally  accepted   accounting   principles.   The  pro  forma
information in the following table is presented for  illustrative  purposes only
and is not  necessarily  indicative  of the  operating  results  that would have
occurred if the  SEEBOARD  acquisition  had taken place at the  beginning of the
period specified,  nor is it necessarily indicative of future operating results.
The following pro forma  information  has been prepared  reflecting the February
1996  issuance  of CSW Common,  and has been  converted  at an exchange  rate of
(pound)1.00=$1.58 for the twelve months ended December 31, 1995.

                                  1995
                               -----------
                          (millions except EPS)

Operating Revenues               $5,404
Operating Income                    750
Net Income for Common Stock         445
EPS of Common Stock               $2.15


19.   QUARTERLY INFORMATION (UNAUDITED)

      The following unaudited quarterly  information includes, in the opinion of
management,  all adjustments  necessary for a fair presentation of such amounts.
Information for quarterly  periods is affected by seasonal  variations in sales,
rate changes, timing of fuel expense recovery and other factors.

                                       65
<PAGE>

QUARTER ENDED                                           1997(1)   1996(2)
-------------------------------------------------------------------------------
                                                    (millions, except EPS)
MARCH 31
    Operating Revenues                                  $1,278    $1,215
    Operating Income                                       127       144
    Income from Continuing Operations                       25        43
    Net Income for Common Stock                             25        51
    Basic and Diluted EPS from Continuing Operations     $0.12     $0.22
    Basic and Diluted EPS                                $0.12     $0.26


JUNE 30
    Operating Revenues                                  $1,184    $1,267
    Operating Income                                       169       214
    Income from Continuing Operations                       83        11
    Net Income for Common Stock                             83       128
    Basic and Diluted EPS from Continuing Operations     $0.39     $0.05
    Basic and Diluted EPS                                $0.39     $0.61

SEPTEMBER 30
    Operating Revenues                                  $1,477    $1,438
    Operating Income                                       303       284
    Income from Continuing Operations                      196       190
    Extraordinary Item                                    (176)     --
    Net Income for Common Stock                             20       190
    Basic and Diluted EPS from Continuing Operations     $0.93     $0.90
    Basic and Diluted EPS from Extraordinary Item       $(0.83)     --
    Basic and Diluted EPS                                $0.10     $0.90

DECEMBER 31
    Operating Revenues                                  $1,329    $1,235
    Operating Income                                       136       153
    Income from Continuing Operations                       25        53
    Net Income for Common Stock                             25        60
    Basic and Diluted EPS from Continuing Operations     $0.11     $0.26
    Basic and Diluted EPS                                $0.11     $0.28

TOTAL
    Operating Revenues                                  $5,268    $5,155
    Operating Income                                       735       795
    Income from Continuing Operations                      329       297
    Extraordinary Item                                    (176)     --
    Net Income for Common Stock                            153       429
    Basic and Diluted EPS from Continuing Operations     $1.55     $1.43
    Basic and Diluted EPS from Extraordinary Item       $(0.83)     --
    Basic and Diluted EPS                                $0.72     $2.07

(1)  The first, second and third quarters of 1997 include the effect of certain
     reclassifications to conform with the 1997 year end financial statement
     presentation.

(2)  In 1996, CSW EPS of Common Stock for the year do not sum to the total of
     the individual quarters' EPS of Common Stock due to different levels of
     average shares outstanding for the different periods.


                                       66
<PAGE>


REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Stockholders and Board of Directors of Central and South West 
Corporation:

      We have audited the  accompanying  consolidated  balance sheets of Central
and South West Corporation (a Delaware  corporation) and subsidiary companies as
of  December  31,  1997 and 1996,  and the related  consolidated  statements  of
income,  stockholders'  equity and cash flows, for each of the three years ended
December 31, 1997.  These  financial  statements are the  responsibility  of the
Corporation's  management.  Our responsibility is to express an opinion on these
financial  statements  based  on our  audits.  We did not  audit  the  financial
statements of CSW Finance  Company (1997 - which includes CSW  Investments)  and
CSW Investments (1996), which statements reflect total assets and total revenues
of 22 percent  and 35  percent  in 1997 and 23  percent  and 36 percent in 1996,
respectively, of the consolidated totals. Those statements were audited by other
auditors whose reports have been furnished to us and our opinion,  insofar as it
relates to the  amounts  included  for those  entities,  is based  solely on the
reports of the other auditors.

      We conducted our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We  believe  that our  audits  and the  reports  of  other  auditors  provide  a
reasonable basis for our opinion.

      In our opinion, based on our audits and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
the  financial  position of Central and South West  Corporation  and  subsidiary
companies  as of  December  31,  1997 and  1996,  and the  related  consolidated
statements of income,  stockholders' equity and cash flows for each of the three
years ended December 31, 1997, in conformity with generally accepted  accounting
principles.


Arthur Andersen LLP

Dallas, Texas
February 16, 1998


                                       67
<PAGE>


AUDITOR'S REPORT TO THE MEMBERS OF CSW UK FINANCE COMPANY

We have audited the  consolidated  balance sheets of CSW UK Finance  Company and
subsidiaries  as of 31 December 1997 and the related  consolidated  statement of
earnings  and  statements  of  cash  flows  for  the  year  then  ended.   These
consolidated  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility is to express an opinion on these  consolidated
financial statements based on our audit.

We conducted our audit in accordance with generally  accepted auditing standards
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable  assurance about whether the financial  statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also  includes  assessing  the  accounting  principles  used in and  significant
estimates  made by  management,  as well as  evaluating  the  overall  financial
statement  presentation.  We believe that our audit provides a reasonable  basis
for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all  material  respects,  the  financial  position of CSW UK Finance
Company and  subsidiaries at 31 December 1997 and the result of their operations
and cash flows for the year then ended in  conformity  with  generally  accepted
accounting principles in the United Kingdom.

Generally accepted  accounting  principles in the United Kingdom vary in certain
significant respects from generally accepted accounting principles in the United
States.  Application of generally accepted  accounting  principles in the United
States would have affected results of operations and shareholders'  equity as of
and for the year ended 31 December  1997 to the extent  summarised in Note 23 to
the consolidated financial statements.



KPMG Audit Plc
Chartered Accountants                                           London, England
Registered Auditor                                              19 January 1998


                                       68
<PAGE>


AUDITOR'S REPORT TO THE MEMBERS OF CSW INVESTMENTS

We  have  audited  the  consolidated  balance  sheets  of  CSW  Investments  and
subsidiaries  as of 31 December 1996 and the related  consolidated  statement of
earnings  and  statements  of  cash  flows  for  the  year  then  ended.   These
consolidated  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility is to express an opinion on these  consolidated
financial statements based on our audit.

We conducted our audit in accordance with generally  accepted auditing standards
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable  assurance about whether the financial  statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also  includes  assessing  the  accounting  principles  used in and  significant
estimates  made by  management,  as well as  evaluating  the  overall  financial
statement  presentation.  We believe that our audit provides a reasonable  basis
for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects,  the financial position of CSW Investments and
subsidiaries  at 31 December  1996 and the result of their  operations  and cash
flows for the year then ended in conformity with generally  accepted  accounting
principles in the United Kingdom.

Generally accepted  accounting  principles in the United Kingdom vary in certain
significant respects from generally accepted accounting principles in the United
States.  Application of generally accepted  accounting  principles in the United
States would have affected results of operations and shareholders'  equity as of
and for the year ended 31 December 1996 to the extent summarised in the notes to
the consolidated financial statements.



KPMG Audit Plc
Chartered Accountants                                           London, England
Registered Auditor                                              22 January 1997

                                       69
<PAGE>


REPORT OF MANAGEMENT

      Management is responsible for the  preparation,  integrity and objectivity
of the consolidated  financial  statements of Central and South West Corporation
and subsidiary  companies as well as other information  contained in this Annual
Report. The consolidated  financial  statements have been prepared in conformity
with generally accepted accounting principles applied on a consistent basis and,
in some cases,  reflect  amounts  based on the best  estimates  and judgments of
management,  giving due  consideration  to  materiality.  Financial  information
contained  elsewhere  in this  Annual  Report  is  consistent  with  that in the
consolidated financial statements.

      The  consolidated   financial   statements  have  been  audited  by  CSW's
independent  public  accountants  who  were  given  unrestricted  access  to all
financial  records  and  related  data,  including  minutes of all  meetings  of
stockholders,  the board of directors and  committees of the board.  CSW and its
subsidiaries  believe  that  representations  made  to  the  independent  public
accountants  during  their  audit were  valid and  appropriate.  The  reports of
independent public accountants are presented elsewhere in this report.

      CSW,  together  with its  subsidiary  companies,  maintains  a  system  of
internal controls to provide reasonable assurance that transactions are executed
in accordance with management's  authorization,  that the consolidated financial
statements  are  prepared  in  accordance  with  generally  accepted  accounting
principles  and  that  the  assets  of CSW and  its  subsidiaries  are  properly
safeguarded against  unauthorized  acquisition,  use or disposition.  The system
includes a documented  organizational  structure and division of responsibility,
established  policies  and  procedures  including a policy on ethical  standards
which  provides that the  companies  will maintain the highest legal and ethical
standards, and the careful selection, training and development of our employees.

      Internal auditors  continuously  monitor the effectiveness of the internal
control  system  following  standards  established  by the Institute of Internal
Auditors. Actions are taken by management to respond to deficiencies as they are
identified. The board, operating through its audit committee, which is comprised
entirely  of  directors  who  are  not  officers  or  employees  of  CSW  or its
subsidiaries, provides oversight to the financial reporting process.

      Due to the inherent limitations in the effectiveness of internal controls,
no internal control system can provide  absolute  assurance that errors will not
occur. However,  management strives to maintain a balance,  recognizing that the
cost of such a system should not exceed the benefits derived.

      CSW and its  subsidiaries  believe  that,  in all material  respects,  its
system of internal  controls over financial  reporting and over  safeguarding of
assets  against  unauthorized   acquisition,   use  or  disposition   functioned
effectively as of December 31, 1997.





E. R. Brooks                  Glenn D. Rosilier             Lawrence B. Connors
Chairman and                  Executive Vice President and  Controller
Chief Executive Officer       Chief Financial Officer

                                       70
<PAGE>


GLOSSARY OF TERMS
The following abbreviations or acronyms used in this Financial Report are 
defined below:

Abbreviation or Acronym    Definition
ACSI.......................American Customer Satisfaction Index(TM) (Survey
                           conducted by the University of Michigan
                           Business School and the American Society of Quality
                           Control)
AEP........................American Electric Power Company, Inc.
AEP Merger.................Proposed Merger between AEP and CSW where CSW would
                           become a wholly owned subsidiary of AEP
APBO.......................Accumulated Postretirement Benefit Obligation
AFUDC......................Allowance for funds used during construction
Alpek......................Alpek S.A. de C.V.
ANI........................American Nuclear Insurance
Arkansas Commission........Arkansas Public Service Commission
Btu........................British thermal unit
Burlington Northern........Burlington Northern Railroad Company
C3 Communications..........C3 Communications, Inc., Austin, Texas (formerly CSW
                           Communications, Inc.)
CAAA.......................Clean Air Act/Clean Air Act Amendments
Cajun......................Cajun Electric Power Cooperative, Inc.
CERCLA.....................Comprehensive Environmental Response, Compensation 
                           and Liability Act of 1980
ChoiceCom..................CSW/ICG ChoiceCom, L.P., a joint venture between C3
                           Communications and ICG Communications, Inc.
CLECO......................Central Louisiana Electric Company, Inc.
Court of Appeals...........Court of Appeals, Third District of Texas, Austin,
                           Texas
CPL........................Central Power and Light Company, Corpus Christi, 
                           Texas
CPL 1997 Final Order.......Final orders received from the Texas Commission in
                           CPL's rate case Docket No. 14965, including both the
                           order received on September 10, 1997 and the revised
                           order received on October 16, 1997
CPL 1997 Original Rate 
  Order....................Final order issued on March 31, 1997 by the Texas
                           Commission in CPL's rate case Docket No. 14965
CPL 1995 Agreement.........Settlement agreement filed by CPL with the Texas
                           Commission to settle certain CPL regulatory matters
CPL 1996 Fuel Agreement....Fuel settlement agreement entered into by CPL and
                           other parties
CSW........................Central and South West Corporation, Dallas, Texas
CSW Common.................CSW common stock, $3.50 par value per share
CSW Credit.................CSW Credit, Inc., Dallas, Texas
CSW Energy.................CSW Energy, Inc., Dallas, Texas
CSW Energy Services........CSW Energy Services, Inc., Dallas, Texas
CSW International..........CSW International, Inc., Dallas, Texas
CSW Investments............CSW Investments, an unlimited company organized in 
                           the United Kingdom through which CSW International 
                           owns SEEBOARD
CSW Leasing................CSW Leasing, Inc., Dallas, Texas
CSW Power Marketing........CSW Power Marketing, Inc., Dallas, Texas
CSW Services...............Central and South West Services, Inc., Dallas, Texas
                           and Tulsa, Oklahoma
CSW System.................CSW and its subsidiaries
CSW UK Finance Company.....CSW Finco, an unlimited company organized in the
                           United Kingdom through which CSW International owns 
                           CSW Investments
CSW U.S. Electric System...CSW and the U.S. Electric Operating Companies
CWIP.......................Construction work in progress
DGES.......................Director General Electricity Supply
DHMV.......................Dolet Hills Mining Venture
DOE........................United States Department of Energy
ECOM.......................Excess cost over market
El Paso....................El Paso Electric Company
El Paso Merger Agreement...Agreement and Plan of Merger between El Paso and CSW,
                           dated as of May 3, 1993, as amended
Energy Policy Act..........National Energy Policy Act of 1992
EnerShop...................EnerShopSM Inc., Dallas, Texas
Entergy Texas..............Entergy Texas Utilities Company
EPA........................United States Environmental Protection Agency
EPS........................Earnings per share of common stock
ERCOT......................Electric Reliability Council of Texas


                                       71
<PAGE>


GLOSSARY OF TERMS  (continued)
The following abbreviations or acronyms used in this Financial Report are 
defined below:

Abbreviation or Acronym    Definition
ERISA......................Employee Retirement Income Security Act of 1974, as
                           amended
Exchange Act...............Securities Exchange Act of 1934, as amended
EWG........................Exempt Wholesale Generator
FASB.......................Financial Accounting Standards Board
FCC........................Federal Communications Commission
FERC.......................Federal Energy Regulatory Commission
FMB........................First mortgage bond
FUCO.......................Foreign utility company as defined by the Holding
                           Company Act
Guadalupe..................Guadalupe-Blanco River Authority pollution control
                           revenue bond issuing authority
HL&P.......................Houston Lighting & Power Company
Holding Company Act........Public Utility Holding Company Act of 1935, as 
                           amended
HVdc.......................High-voltage direct-current
IBEW.......................International Brotherhood of Electrical Workers
ISO........................Independent system operator
ITC........................Investment tax credit
KW.........................Kilowatt
LIFO.......................Last-in first-out (inventory accounting method)
Louisiana Commission.......Louisiana Public Service Commission
LTIP.......................Long-Term Incentive Plan
MD&A.......................Management's Discussion and Analysis of Financial
                           Condition and Results of Operations
MDEQ.......................Mississippi Department of Environmental Quality
MGP........................Manufactured gas plant or coal gasification plant
Mirror CWIP................Mirror construction work in progress
Mississippi Power..........Mississippi Power Company
MMbtu......................Million Btu
MW.........................Megawatt
MWH........................Megawatt-hour
National Grid..............National Grid Group plc
NEIL.......................Nuclear Electric Insurance Limited
NRC........................Nuclear Regulatory Commission
OASIS......................Open access same time information system
Oklahoma Commission........Corporation Commission of the State of Oklahoma
Oklaunion..................Oklaunion Power Station Unit No. 1
OPEB.......................Other postretirement benefits (other than pension)
PCB........................Polychlorinated biphenyl
PowerShare.................CSW's PowerShareSM Dividend Reinvestment and Stock
                           Purchase Plan
PRP........................Potentially responsible party
PSO........................Public Service Company of Oklahoma, Tulsa, Oklahoma
PSO 1997 Rate Settlement 
  Agreement................Joint stipulation agreement reached by PSO and other
                           parties to settle PSO's rate inquiry
PURA.......................Public Utility Regulatory Act of Texas (including
                           amendments to the law)
PURPA......................Public Utility Regulatory Policies Act of 1978
RCRA.......................Federal Resource Conservation and Recovery Act of
                           1976
Retirement Plan............CSW's tax-qualified Cash Balance Retirement Plan
Rights Plan................Stockholders Rights Agreement between CSW and CSW
                           Services, as Rights Agent
RUS........................Rural Utilities Service of the federal government
SEC........................United States Securities and Exchange Commission
SEEBOARD...................SEEBOARD plc., Crawley, West Sussex, United Kingdom
SEEBOARD U.S.A.............CSW's investment in SEEBOARD consolidated and
                           converted to U.S. Generally Accepted Accounting 
                           Principles
SFAS.......................Statement of Financial Accounting Standards
SFAS No. 52................Foreign Currency Translation
SFAS No. 71................Accounting for the Effects of Certain Types of 
                           Regulation
SFAS No. 87................Employers' Accounting for Pensions
SFAS No. 106...............Employers' Accounting for Postemployment Benefits
SFAS No. 115...............Accounting for Certain Investments in Debt and Equity
                           Securities
SFAS No. 123...............Accounting for Stock-Based Compensation



<PAGE>


GLOSSARY OF TERMS  (continued)
The following abbreviations or acronyms used in this Financial Report are 
defined below:

Abbreviation or Acronym    Definition
SFAS No. 125...............Accounting for Transfers and Servicing of Financial
                           Assets and Extinguishment of Liabilities
SFAS No. 128...............Earnings Per Share
SFAS No. 130...............Reporting Comprehensive Income
SFAS No. 131...............Disclosure about Segments of an Enterprise and 
                           Related Information
SPP........................Southwest Power Pool
STP........................South Texas Project nuclear electric generating 
                           station
STPNOC.....................STP Nuclear Operating Company, a non-profit Texas
                           corporation, jointly owned by CPL, HL&P, City of 
                           Austin, and City of San Antonio
SWEPCO.....................Southwestern Electric Power Company, Shreveport,
                           Louisiana
SWEPCO Plan................The plan of reorganization for Cajun filed by the
                           Members Committee and SWEPCO on January 15, 1998 with
                           the U.S. Bankruptcy Court for the Middle District of
                           Louisiana
Tejas......................Tejas Gas Corporation
Texas Commission...........Public Utility Commission of Texas
Transok....................Transok, Inc. and subsidiaries, Tulsa, Oklahoma
Trust Preferred 
  Securities...............Collective term for securities issued by business
                           trusts of CPL, PSO and SWEPCO classified on the 
                           balance sheet as "Certain Subsidiary-obligated, 
                           mandatorily redeemable preferred securities of 
                           subsidiary trusts holding solely Junior Subordinated
                           Debentures of such Subsidiaries"
Union Pacific..............Union Pacific Railroad Company
U.S. Electric or U.S. 
   Electric Operating 
   Companies...............CPL, PSO, SWEPCO and WTU
Vale.......................Empresa De Electricidade Vale Paranapanema S/A
WTU........................West Texas Utilities Company, Abilene, Texas
WTU 1995 Stipulation and
  Agreement................Stipulation and Agreement to settle certain WTU 
                           regulatory matters